SB-2 1 doc1.txt ** As Filed With The Securities And Exchange Commission On May 1, 2003 Registration No. ________________ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ENVIRONMENTAL SAFEGUARDS, INC. (Name Of Small Business Issuer In Its Charter) NEVADA 87-0429198 4953 (State Or Other Jurisdiction (Primary Standard (I.R.S. Employer Of Incorporation Industrial Classification Identification Number) Or Organization) Code Number) 2600 South Loop West, Suite 645 Houston, Texas 77054 (713) 641-3838 (Address and Telephone Number Of Principal Executive Offices Business) James S. Percell Chief Executive Officer c/o Environmental Safeguards, Inc. 2600 South Loop West, Suite 645 Houston, Texas 77054 voice: (713) 641-3838 fax: (713) 641-0756 (Name, Address, And Telephone Number, Of Agent For Service Of Process) Copy To: Robert D. Axelrod, Esq. Axelrod, Smith & Kirshbaum 5300 Memorial Drive, Suite 700 Houston, Texas 77007 voice: (713) 861-1996 ext. 116 fax: (713) 552-0202 Approximate Date Of Commencement Of Proposed Sale To The Public: As soon as practicable after the Registration Statement becomes effective. 1 If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [X]
CALCULATION OF REGISTRATION FEE PROPOSED MAXIMUM TITLE OF EACH OFFERING MAXIMUM CLASS OF SECURITIES PROPOSED PRICE AGGREGATE REGISTRATION AMOUNT TO BE PER OFFERING TO BE REGISTERED REGISTERED SHARE(*) PRICE(*) FEE ----------------------------------------------------------------------- Common Stock, par value $0.001, underlying Warrants 1,500,000 $ 0.22(1) $330,000.00(1) $ 26.73
--------------- (*) Estimated solely for the purpose of calculating the registration fee. Calculated pursuant to Rule 457(g) and based on the average bid and asked price of our common stock on April 25, 2003. Estimated legal, accounting, blue sky, transfer agent and printing fees are $35,600.00. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVENESS DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. 2 PART I INFORMATION REQUIRED IN PROSPECTUS 3 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. Subject To Completion, Dated May 1, 2003. ENVIRONMENTAL SAFEGUARDS, INC. 1,500,000 SHARES OF COMMON STOCK This Prospectus relates to the resale of 1,500,000 shares of common stock, par value $0.001 per share that may be offered and sold from time to time by the selling security holder listed on page 43. Our common stock is traded on the Over the Counter Bulletin Board (the OTCBB) under the symbol "ELSF." On April 25, 2003, the closing bid for our common stock on the OTCBB was $0.22 per share. OUR COMMON STOCK IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK AND SHOULD NOT BE PURCHASED BY INVESTORS WHO CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. YOU SHOULD CAREFULLY READ AND CONSIDER OUR RISK FACTORS SECTION ON PAGE 11 BEFORE MAKING AN INVESTMENT DECISION. NEITHER THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACT OR ACCURACY OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The Date Of This Prospectus Is ____________ ___, 2003. 4 NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, ANY SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY US OR ANY OTHER PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCE, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR ITS SUBSIDIARIES SINCE THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY STATE WHERE SUCH OFFER WOULD BE UNLAWFUL. YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. THE SELLING SECURITY HOLDER IS OFFERING TO SELL, AND SEEKING OFFERS TO BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS OR OF ANY SALE OF COMMON STOCK. 5
TABLE OF CONTENTS Page AVAILABLE INFORMATION 8 FORWARD-LOOKING STATEMENTS 8 PROSPECTUS SUMMARY 10 RISK FACTORS 11 USE OF PROCEEDS 15 PRICE RANGE OF COMMON STOCK 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16 BUSINESS 25 PROPERTIES 31 MANAGEMENT 32 LIMITATION ON DIRECTORS' LIABILITY; INDEMNIFICATION 34 EXECUTIVE COMPENSATION 35 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 39 PRINCIPAL STOCKHOLDERS 41 PLAN OF DISTRIBUTION 43 SELLING STOCKHOLDER 44 DESCRIPTION OF SECURITIES 45 LEGAL MATTERS 47 LEGAL PROCEEDINGS 47 6 EXPERTS 48 CHANGES IN COMPANY'S CERTIFYING ACCOUNTANT 48 CONSOLIDATED FINANCIAL STATEMENTS F-1
7 AVAILABLE INFORMATION We are currently subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and we file periodic reports, proxy materials and other information with the Securities and Exchange Commission ("Commission"). In addition, we will furnish stockholders with annual reports containing audited financial statements certified by our independent accountants and interim reports containing unaudited financial information as it may be necessary or desirable. We will provide without charge to each person who receives a copy of this Prospectus, upon written or oral request, a copy of any information that is incorporated by reference in this Prospectus (not including exhibits to the information that is incorporated by reference unless the exhibits are themselves specifically incorporated by reference). Such request should be directed to Environmental Safeguards, Inc., Attn. James S. Percell, President, 2600 South Loop West, Suite 645, Houston, Texas 77054, tel. (713) 641-3838. Our web site is www.onsite2.com. We have filed with the Commission a Registration Statement under the Act with respect to the securities offered by this Prospectus. This Prospectus does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. For further information with respect to us and this offering, reference is made to the Registration Statement, including the exhibits filed therewith, that may be inspected without charge at the public reference room maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, tel. 1-800-SEC-0330. Copies of such material may also be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission maintains a web site on the Internet that contains reports, proxy and information statements and other information regarding issuers that file electronically with the Commission. The address of the SEC web site is www.sec.gov. Visitors to the site may access such information by searching the EDGAR data base on the SEC's web site. FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements about our future. Forward-looking statements include statements about our: - plans - objectives - goals - strategies - expectations for the future - future performance and events - underlying assumptions for all of the above - other statements that are not statements of historical facts Such forward-looking statements involve risks and uncertainties that could cause our actual results to materially differ from our forward-looking statements. Words such as "plan", "expects", "anticipates", "estimates" and 8 similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties are set forth below. Our expectations, beliefs and projections are expressed in good faith and are believed to have a reasonable basis, including without limitation, our examination of historical operating trends, data contained in our records and other data available from third parties. We make these forward-looking statements based on our analysis of internal and external historical trends, but there can be no assurance that we will achieve the results set forth in these forward-looking statements. Our forward-looking statements are expressed in good faith and we believe that there is a reasonable basis for us to make them. There can be no assurance, however, that our expectations, beliefs or projections will result, be achieved, or be accomplished. In addition to other factors and matters discussed in this prospectus, the following are important factors that, in our view, could cause our actual results to materially differ from our forward-looking statements, and could cause material adverse affects on our financial condition and results of operations: our ability to secure contracts for our ITD units; our ability to attain widespread market acceptance of our technology; our ability to obtain acceptable forms and amounts of financing; the demand for, and price level of, our services; competitive factors; the actual useful life of our ITD Units; ability to mitigate concentration of business in a small number of customers; the evolving industry and technology standards; the ability to protect proprietary technology; the dependence on key personnel; the effect of business interruption due to political unrest; and our ability to maintain acceptable utilization rates on our equipment. We are not obligated to update or revise these forward-looking statements to reflect the occurrence of future events or circumstances. 9 PROSPECTUS SUMMARY SUMMARY OF INFORMATION IN THE PROSPECTUS This prospectus summary highlights selected information contained in this prospectus. To understand this offering fully, you should read the entire prospectus carefully, including the risk factors beginning on page 11 and the financial statements beginning on page F-1. Unless otherwise indicated, this prospectus assumes that none of our outstanding options or warrants are exercised into shares of our common stock, nor any shares of our Series B Preferred Stock or Series D Preferred Stock are converted into shares of our common stock. All dollar amounts in this Prospectus are stated in U.S. dollars. THE COMPANY We were incorporated under the laws of the State of Nevada in 1985. In 1993, we changed our name to Environmental Safeguards, Inc. We are engaged in the development, production and sale of environmental remediation and recycling technologies and services to oil and gas industry participants, waste management companies and other industrial customers, through our wholly-owned subsidiaries National Fuel & Energy, Inc. ("NFE") and OnSite Technology, L.L.C. ("OnSite"). References to us include our subsidiaries. During the period from 1996 until 2000, a substantial portion of our revenues were generated from major international oil and gas industry participants in Colombia, Venezuela and Mexico, as well as other domestic and foreign industrial applications. As of April 2003 we have completed our foreign contract operations, and we have taken steps to close down some of our foreign subsidiaries. We are now concentrating our marketing efforts and resources on domestic downstream plants, manufacturing facilities and waste management facilities, where our proprietary equipment and process have a competitive advantage in waste minimization, and in the recycling and reuse of waste streams. As of April 2003, OnSite operates internationally through its wholly-owned subsidiary OST Equipment Leasing L.L.C, and its 50%-owned subsidiary, OnSite Arabia, Inc. OnSite is in the process of liquidating our OnSite Colombia, Inc. and OnSite Mexico, L.L.C. subsidiaries. Onsite has completely closed down our OnSite Venezuela, Inc. and OnSite Environmental UK Ltd. subsidiaries. The environmental remediation and recycling services that we provide involve the removal of hydrocarbon contaminants from solids using indirect thermal desorption remediation and recycling technology. We provide these services on-site or at the central location to which the customer hauls the contaminated materials. Our offices are located at 2600 South Loop West, Suite 645, Houston, Texas 77054, tel. (713) 641-3838. Our web site is www.onsite2.com. 10
THE OFFERING Common stock outstanding as of April 25, 2003 10,112,144 shares of common stock Common stock to be offered by our selling stockholder 1,500,000 shares of common stock underlying warrants. The market for our common stock Our common stock trades on the Over-the Counter Bulletin Board, also called the OTCBB, under the trading symbol "ELSF". The market for our common stock is highly volatile. We can provide no assurance that there will be a market in the future for our common stock.
RISK FACTORS Any investment in shares of our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this prospectus, before you decide to buy our common stock. If any of the following risks actually occur, our business would likely suffer. In such circumstances, the market price of our common stock could decline, and you may lose all or part of the money you paid to buy our common stock. NEW MARKETING FOCUS As of April 2003 we have for the most part completed our foreign contract operations that were primarily recycling and reclamation at oil drilling sites. We have taken steps to close down some of our foreign subsidiaries. We are now concentrating our marketing efforts and resources on domestic downstream plants, manufacturing facilities and waste management facilities, where our proprietary equipment and process have a competitive advantage in waste minimization, and in the recycling and reuse of waste streams. This represents a re-focusing of our marketing efforts. Our new marketing strategy may not generate sufficient revenue to sustain our operations. CONCENTRATION OF CUSTOMERS. We have a limited number of customers to whom we provide services. The loss of any particular customer could have an adverse impact on our financial position. 11 WE COULD HAVE LIABILITY UNDER ENVIRONMENTAL LAWS. We face all of the risks inherent in the hazardous and industrial waste industries because we handle chemical waste products. Although our work is done onsite at the customer's location, and although our recycling and reclamation process vaporizes the wastes, we nonetheless handle such waste products. Although we presently provide remediation services that meet applicable federal and state standards, the government can impose new standards that we might not be able to meet. IN RECENT YEARS, WE HAVE INCURRED SUBSTANTIAL NET LOSSES FROM OPERATIONS. We incurred net losses from operations of $3,683,000 in 2001 and $ 3,176,000 in 2002. In order to attain profitability, we must secure contracts at acceptable processing prices and control costs so as to produce a positive operating margin. There can be no assurance we can do so, and the failure to maintain profitability could ultimately result in our inability to pay our financial obligations as they become due. At December 31, 2002, we had a working capital deficit of $1,186,000 and positive working capital of $ 766,000 at December 31, 2001. Our presently existing capital resources may not be sufficient for us to maintain our current and planned operations through the remainder of 2003. We have historically funded operations through a combination of internally generated cash and borrowing. Until such time as our operating results improve sufficiently to fund our operations, we must obtain outside financing to fund the expansion of our business and to pay our obligations as they become due. There is no assurance that we can raise funds under terms that are acceptable to us. Any additional debt or equity financing may be dilutive to the interests of our Shareholders. LIQUIDITY REQUIREMENTS. We have experienced significant recurring losses from operations in 2002 and 2001, that have caused liquidity problems. Although we borrowed $1,500,000 in March 2003, there can be no assurance that our long-term liquidity or capital resources will be sufficient to maintain our business operations. FOREIGN POLITICAL CLIMATE. Although we have substantially exited foreign markets except for the Arabian Gulf region through OnSite Arabia, we could pursue additional foreign markets again in the future. Any adverse circumstances in the foreign political climate could have a negative impact on us. Other than our operations through OnSite Arabia, we have no plans to operate in foreign markets at this time. INTERNATIONAL TRANSACTIONS. Our operations in foreign markets expose us to foreign exchange and currency risks. We could have to losses due to foreign exchange rates. 12 CAPITAL REQUIREMENTS. Our ability to grow is directly related to our ability to be profitable or to raise funds. As of April 2003, we owned five ITD units outright, and had a 50% interest in two additional units owned by our 50%-owned subsidiary OnSite Arabia, Inc. However, we do not have the financial resources to build more ITD Units. This could limit the size of our business. There is no assurance that capital will be available in the future to build more ITD Units. The sale of equity securities could dilute our existing stockholders' interest, and borrowings from third parties could result in our assets being pledged as collateral and loan terms that would increase our debt service requirements. FABRICATION OF ITD UNITS. In the past, we have used outside fabricators to construct the ITD Units to our specifications. Deficient fabrication or financial instability of a fabricator could upset our ability to manufacture the ITD Units on a timely basis that could result in delays in fulfilling contracts for recycling and remediation. Presently, we have no plans to build more ITD Units. LIABILITY FOR TOXIC TORTS. Toxic tort litigation has increased markedly in recent years as persons allegedly injured by chemical contamination seek recovery for personal injuries or property damage. These legal developments present a risk of liability should we be held responsible for contamination or pollution. COMPETITION. There are many companies that currently dispose of hazardous and industrial wastes and remediate or clean up sites that have been contaminated, and such companies are continually attempting to develop new and improved products and services. Other companies utilize competing technologies and techniques in an attempt to provide more economical or superior remediation services. Our competitors are well established companies with substantially greater capital resources, larger research and development staffs and facilities and substantially greater marketing capabilities than us. No assurances can be given that we will be able to successfully compete with such companies or alternative technologies. TECHNOLOGICAL OBSOLESCENCE. We use a method called indirect thermal desorption to remediate waste. There is no assurance that this technology will be marketable in the future. Other technologies could make our services obsolete. OPERATING RISKS AND POSSIBLE INSUFFICIENCY OF INSURANCE. 13 Our business exposes us to various risks, including claims for damage to property, injuries to persons, negligence and professional errors or omissions in the planning or performing of services. There is no assurance that the liability insurance that we carry is sufficient. DEPENDENCE ON MANAGEMENT. We are dependent upon the time, talent and experience of James S. Percell, our President and Chief Executive Officer. The loss of the services of Mr. Percell, for any reason, could have a material adverse effect on us. NEED FOR ADDITIONAL PERSONNEL. As a result of a recent restructuring of our operations, we will hire additional staff. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining such personnel. SHARES ELIGIBLE FOR FUTURE SALE. Possible or actual sales of a substantial number of shares of common stock by the selling stockholder in this offering could have a negative impact on the market price of our common stock. No prediction can be made as to the effect, if any, that sales of shares of common stock or the availability of such shares for sale will have on the market prices prevailing from time to time. Nevertheless, the possibility that substantial amounts of common stock may be sold in the public market would likely have a material adverse effect on prevailing market prices for the common stock and could impair our ability to raise capital through the sale of our equity securities. OUTSTANDING OPTIONS AND WARRANTS; CONVERSION OF PREFERRED STOCK; DILUTION. We presently have outstanding an aggregate of 7,801,442 options and warrants to purchase common stock. The exercise of the outstanding options and warrants would result in the dilution of interests of our other stockholders. We presently have outstanding shares of preferred stock and the deferred dividends and interest on the preferred stock that may be converted into common stock. If all of the preferred stock and the deferred dividends and interest on the preferred stock (as calculated as of March 31, 2003) were to be converted into common stock, then we would be required to issue an aggregate of 15,415,269 shares of common stock. The conversion of all of the preferred stock would result in a substantial dilution of interests of our other stockholders. NO ASSURANCE OF A PUBLIC MARKET. There is currently only a limited market for our common stock that we characterize a limited market due to the relatively limited number of shares in the public float, the relatively low trading volume and the small number of brokerage firms acting as market makers. The market for low priced securities is generally less liquid and more volatile than securities traded on national 14 stock markets. Fluctuations in market prices are not uncommon. No assurance can be given that the market for the our common stock will continue or that the stock price will be maintained. Even if the shares of common stock are registered for resale to the public under the Securities Act of 1933, as amended (the "Act") and secondary trading exemptions under state securities laws are available, there may not be an active market for the shares of common stock. NO CASH DIVIDENDS. We have never paid cash dividends on our common stock and it is unlikely that we will do so in the future. The only way you may be able to make a profit on your investment is to sell your common stock. USE OF PROCEEDS We will not receive any proceeds upon the sale of the common stock issuable upon the exercise of the warrants by the selling stockholder. We will pay for the cost of registering the shares of common stock in this offering. The warrants were issued in connection with our borrowing $1,500,000 from the selling stockholder. We are using the loan proceeds for working capital and general corporate purposes. If all of the warrants are exercised, than we will receive an aggregate $15,000 that we plan to use for working capital and general corporate purposes. The warrants are immediately exercisable and expire on April 30, 2005. The warrant holder may exercise all or some of the warrants from time to time until the warrants expire. PRICE RANGE OF COMMON STOCK Our Common Stock commenced trading on the OTC Bulletin Board under the symbol "ELSF" on October 17, 2002. Prior to that, for the periods set forth below, our common stock traded on the American Stock Exchange under the symbol "EVV". The following table sets forth the range of high and low closing sales prices of our Common Stock for the periods shown:
COMMON STOCK PRICE RANGE HIGH LOW 2001 First Quarter . . . . . . . . . . . . . $ 0.43 $ 0.15 Second Quarter. . . . . . . . . . . . . $ 0.20 $ 0.05 Third Quarter . . . . . . . . . . . . . $ 0.16 $ 0.08 Fourth Quarter. . . . . . . . . . . . . $ 0.38 $ 0.06 2002 First Quarter . . . . . . . . . . . . . $ 0.40 $ 0.20 Second Quarter. . . . . . . . . . . . . $ 0.28 $ 0.12 Third Quarter . . . . . . . . . . . . . $ 0.18 $ 0.03 Fourth Quarter. . . . . . . . . . . . . $ 0.08 $ 0.02 15 2003 First Quarter . . . . . . . . . . . . . $ 0.36 $ 0.04 Second Quarter through April 25, 2003 . $ 0.28 $ 0.12
On April 25, 2003, the closing price of our common stock was $0.22 per share. On the same date, we had approximately 166 stockholders of record, including broker dealers holding shares beneficially owned by their customers.
EQUITY COMPENSATION PLAN INFORMATION NUMBER OF SECURITIES REMAINING AVAILABLE NUMBER OF SECURITIES FOR FUTURE ISSUANCE TO BE ISSUED UPON WEIGHTED-AVERAGE UNDER EQUITY EXERCISE OF EXERCISE PRICE OF COMPENSATION PLANS OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) PLAN CATEGORY (a) (b) (c) ------------------- --------------------- ---------------------- ------------------------- Equity compensation plans approved by security holders 747,500 $ 1.29 52,500 Equity compensation plans not approved by security holders 4,241,162 1.34 - --------------------- ---------------------- ------------------------- Total 4,988,662 $ 1.33 52,500 ===================== ====================== =========================
For information relating to the equity compensation plans, reference is made to Financial Note 8 to our audited Financial Statements for the year ended December 31, 2002 under the subsection "Stockholders' Equity-Stock Options." These Financial statements begin on page F-1. DIVIDEND POLICY We have not paid, and do not currently intend to pay cash dividends on our common stock in the foreseeable future. The current policy of our Board of Directors is to retain all earnings, if any, to provide funds for the operation and expansion of our business. The declaration of dividends, if any, will be subject to the discretion of our Board of Directors, that may consider such factors as our results of operations, financial condition, capital needs and acquisition strategy, among other factors. Our Series B Preferred Stock is entitled to receive dividends at such time, if any, that we declare dividends on our common stock, in an amount equal to the number of shares of common stock that the Series B Preferred Stock could be converted into at the time a dividend is declared. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and the related notes beginning on page F-1, and the section entitled "Forward-Looking Statements" on page 8 that discuss certain limitations inherent in such statements. 16 INFORMATION REGARDING AND FACTORS AFFECTING FORWARD-LOOKING STATEMENTS We are including the following cautionary statement in this prospectus to make applicable and take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by us, or on behalf of us. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are other than statements of historical facts. Certain statements in this prospectus are forward-looking statements. Words such as "expects", "anticipates", "estimates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties are set forth below. Our expectations, beliefs and projections are expressed in good faith and are believed to have a reasonable basis, including without limitation, our examination of historical operating trends, data contained in our records and other data available from third parties. There can be no assurance, however, that our expectations, beliefs or projections will result, be achieved, or be accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in our view, could cause material adverse affects on our financial condition and results of operations: our ability to secure contracts for our ITD units; our ability to attain widespread market acceptance of our technology; our ability to obtain acceptable forms and amounts of financing; the demand for, and price level of, our services; competitive factors; the actual useful life of our ITD Units; ability to mitigate concentration of business in a small number of customers; the evolving industry and technology standards; the ability to protect proprietary technology; the dependence on key personnel; the effect of business interruption due to political unrest; and our ability to maintain acceptable utilization rates on our equipment. We are not obligated to update or revise these forward-looking statements to reflect the occurrence of future events or circumstances. OVERVIEW We are engaged in the development, production and sale of environmental recycling technologies and services to waste management companies, oil and gas companies and other industrial customers through our wholly owned subsidiary, OnSite Technology, L.L.C. ("OnSite"). We are devoting substantially all of our efforts to the development of markets for OnSite's services. We are currently providing recycling services to companies engaged in waste management, refining, and other industrial applications. Refining and other types of industrial activities, often produce significant quantities of petroleum-contaminated waste, from which our Indirect Thermal Desorption ("ITD") process can extract and recover the hydrocarbons as re-useable or re-saleable liquids, and produce recycled solids compliant with environmental regulations. The activities of OnSite include use of ITD technology to address hydrocarbon contamination problems and hydrocarbon recycling and reclamation opportunities at heavy industrial, refining, petrochemical and waste management sites, as well as at Superfund, DOD and DOE sites. 17 On December 17, 1997, we acquired the remaining 50% interest in OnSite from Parker Drilling Co. ("Parker"), giving us complete control of the ITD technology owned by OnSite, and providing us with a wholly-owned operating subsidiary that forms the cornerstone of our operations. Total purchase consideration in the OnSite acquisition was financed by us through a private placement of Convertible Preferred and Preferred Stock, combined with senior secured notes and warrants to purchase shares of our common stock. We included OnSite's operating results in our statement of operations for the year ended December 31,1997, as though the acquisition took place at the beginning of that year, and deducted as a separate line item the pre-acquisition earnings attributable to the former 50% owner of OnSite. We have focused essentially all of our attention on our now wholly-owned business operations in OnSite. OnSite was formed, as a 50%-owned joint company with Parker, as a means for assembling the capital necessary to build and improve the ITD process and to generate market awareness and acceptance of ITD technology. We expect that a substantial portion of our revenues will continue to be generated from waste management, petrochemical, and industrial applications. During the period from 1996 until 2000 a substantial portion of our revenues were generated from major international oil and gas industry participants in Latin America (Colombia, Venezuela and Mexico) as well as from other domestic and foreign industrial applications. As of April 2003 we have for the most part completed our foreign contract operations, and have in fact taken steps to close down certain of our foreign subsidiaries as outlined below. We are now concentrating our marketing efforts and resources on domestic downstream plants, manufacturing facilities and waste management facilities, where our proprietary equipment and process have a competitive advantage in waste minimization, and recycling/reuse of hazardous waste markets -- including industrial, petroleum and petro-chemical waste streams. Highlights of our foreign operations: OnSite Colombia, Inc. ("OSC"): In November 1996, we formed a 50%-owned joint company OSC to provide hydrocarbon contaminated soil recycling services to oil and gas industry participants operating in Colombia. Having completed contract operations in Colombia, we re-acquired the 50% minority ownership of OSC and subsequently initiated formal procedures to close-down OSC. As of April 2003 the close-down process was in its final stages. OnSite Venezuela, Inc. ("OSV"): In January 1998, we formed our 100% owned subsidiary OSV, and commenced operations to provide hydrocarbon contaminated soil recycling services to oil and gas industry participants operating in Venezuela. Following completion of contract operations in Venezuela, the close-down of this entity was completed. OnSite Arabia, Inc. ("OSA"): In December 1998, we formed a 50%-owned joint company OSA to provide hydrocarbon contaminated soil recycling services to oil and gas industry participants operating in the Arabian Gulf region. 18 OnSite Environmental UK, Ltd. ("OSE"): In April 1999, we formed OSE, a wholly-owned subsidiary, for operations in Scotland. Having completed contract operations in Scotland, the close-down of this entity was completed. OnSite Mexico LLC ("OSM"): In July 1999, we registered OSM, a wholly-owned subsidiary, for operations in Mexico. OSM has completed operations and its close-down procedures have commenced. OST Ambiental S de RL de CV ("SRL"): In March 2001, we registered SRL, a wholly-owned subsidiary, for operations in Mexico. SRL has recently completed all operations and its close-down procedures have been completed. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, that have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. These estimates and assumptions provide a basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our estimates under different assumptions or conditions, and these differences may be material. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We recognize revenue at the time services are performed, or in the event of the sale of an ITD unit, when the equipment is shipped. We record property and equipment at cost and compute depreciation using the straight-line method over an estimated useful live of 8 years on our ITD Units and 3 to 5 years on our office furniture and equipment and transportation and other equipment. Effective October 1, 2002, we changed the estimated useful lives of our ITD units from 5 years to 8 years to more accurately reflect our experience with the useful lives of the units and to conform to industry practices for equipment used in similar applications. Any additions or improvements that increase the value or extend the life of our assets are capitalized and expenditures for normal maintenance and repairs are expensed as incurred. Disposals are removed from the accounts at cost less accumulated depreciation and any gain or loss from disposition is reflected in operations currently. 19 RESULTS OF OPERATIONS COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 Summary. For the year ended December 31, 2002, we had a net loss of $3,043,000 as compared to a 2001 net income of $1,507,000. The decrease in earnings was primarily the result of a non-recurring gain on sale of three ITD units and certain technical rights during the fourth quarter of 2001. Additional information follows. Revenue and Gross Margin. Revenue of $943,000 for 2002 generated a $1,025,000 negative gross margin as compared to revenue of $2,987,000 and a negative gross margin of $559,000 in 2001. The decrease in revenue and gross margin was due to a substantial drop in ITD utilization during 2002. On average we had 0.1 units in operation in 2002 as compared to 1.8 units during 2001. The decreased utilization was due to the completion of contract operations in Mexico at the end of 2001. Selling, General and Administrative ("SGA") Expense. SGA expenses during 2002 were nearly 35% below the prior year level primarily due to the winding-down of contract operations in Colombia, Mexico, and Venezuela. Additional savings were recognized by reductions in SGA expenses in the U.S Amortization of Engineering Design and Technology. This represents the amortization of Acquired Engineering Design and Technology costs, an intangible asset related to the December 1997 acquisition of the remaining 50% interest in OnSite from Parker Drilling. The intangible asset is being amortized over an 8-year estimated economic life. Research & Development Costs ("R&D") Expense. The expense for 2002 is $30,000 as compared to $71,000 for 2001. This expense reflects ongoing R&D improvements to our Series 6000 ITD system design. Interest Expense. During 2002, $43,000 of interest expense was incurred, compared to interest expense of $839,000 for 2001 (including amortization of debt issuance costs of $344,000). The decrease in interest expense for 2002 was mainly due to the retirement of all of our senior debt at the end of 2001. Other Income (Expense). The category "Other" is mainly composed of foreign currency translation gains and losses. The financial statements of our foreign subsidiaries are measured as if the functional currency was the U.S. Dollar ("USD"). The re-measurement of local currencies into USD created favorable (unfavorable) translation adjustments that were included in net income in each respective year 2002 and 2001. Income Taxes. The $79,000 tax benefit in 2002 is the result of a refund of 2001 federal income tax. Approximately half of the 2001 tax provision relates to state income tax effects, with the balance due to foreign income tax effects mainly in our Mexico subsidiaries. We incurred net operating losses ("NOLs") in the U.S. in recent years, some of which were used in 2001 to offset taxes on our 20 2001 taxable income. The balance of our NOLs may be used to offset taxable income reported in future periods. The NOLs have generated deferred tax assets, but due to uncertainties regarding the future realization of these assets, a valuation allowance has been provided for the full amount of the deferred tax assets. However, presently there can be no assurances that the NOLs will be utilized. Minority Interest. Minority interest for 2002 reflects our 50% minority partner's interest in the net loss of OnSite Arabia because our Colombian operations were completed and Colombian subsidiary closed down in 2001. During 2001, minority interest reflects our 50% minority partner's interest in the net loss of OnSite Colombia and OnSite Arabia. LIQUIDITY AND CAPITAL RESOURCES We currently have no significant commitments for capital expenditures. Since our inception, we have expended a significant portion of our resources to develop markets and industry awareness of our ITD remediation and recycling/reclamation process technology. Our efforts have been focused primarily on hydrocarbon soil contamination inherent in oil and gas exploration activities. Our efforts to develop markets and produce equipment have required significant amounts of capital. In December 2001 we completed the sale of three of our ITD units along with certain licensing rights, and utilized the bulk of the proceeds from the sale to retire our senior debt. With the exception of this sale, we have incurred recurring net losses and have been dependent on revenue from a limited customer base to provide cash flows. We completed our most significant service contract in December 2000 and during 2001 and 2002 have been exploring ways to replace that revenue. During 2001 and 2002 we've experienced a continued tightening of cash reserves and prior to repaying our senior debt in December 2001, we took actions to delay payments on that debt. In January 2003 we signed a contract to process various waste streams at a facility in Arkansas. We are currently seeking to obtain additional service contracts in our served markets and are considering strategic alternatives including the possible additional sale of certain of our assets. To the extent our cash reserves and cash flows from operations are insufficient to meet future cash requirements, we will need to successfully raise funds through an equity infusion, the issuance of debt securities or the sale of ITD units. Financing may not be available on terms acceptable to us, or at all. Further, the sale of additional equity or convertible debt securities may result in dilution to our stockholders. During July 2002, we obtained uncollateralized loans totaling $250,000 from Cahill Warnock Strategic Partners, L. P. and Strategic Associates, L.P. These loans bear interest at 12% per year and are due in September 2003. During March 2003, we obtained a loan of $1,500,000 from a private investor group. The loan is to be funded in three $500,000 fundings on March 20, 2003; May 15, 2003; and August 15, 2003. The initial funding of March 20, 2003 has been received. The loan is collateralized by three ITD units and bears interest 21 at 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. Warrants to purchase 1,500,000 shares of our common stock at a price of $0.01 were issued in connection with this loan. We expect that our existing cash reserves, cash flows from operations, and our borrowing of $1,500,000 in March 2003 will be sufficient to cover our cash requirements for 2003. However, there can be no assurance that existing sources of cash will cover our 2003 cash flow requirements. Our previous auditor included an explanatory paragraph in their auditor's report on the Company's consolidated financial statements, as of December 31, 2001 and for the two years in the period then ended, describing the uncertainty about our ability to continue as a going concern. Our present auditors issued an unqualified opinion, without a going concern explanatory paragraph, on the Company's 2002 financial statements. The functional currency of our foreign operations is the U.S. dollar because customer invoicing, customer receivables, imported equipment and many of the operating cost factors are denominated in U.S. dollars. We plan to continue to implement the same approach to minimize our risks associated with foreign exchange fluctuation and its affect on our profitability. ACCOUNTING MATTERS AND RECENTLY ISSUED PRONOUNCEMENTS In June 1998 and June 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", respectively. These statements establish accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS Nos. 133 and 138 also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133 and 138 are effective for fiscal years beginning after June 15, 2000. We do not currently hold derivative instruments or engage in hedging activities and, accordingly, the adoption of these new standards is not expected to have a material impact on our results of operations or financial position. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," that requires all business combinations initiated after June 30, 2001 be accounted for using the purchase method. In addition, SFAS No. 141 further clarifies the criteria to recognize intangible assets separately from goodwill. Specifically, SFAS No. 141 requires that an intangible asset may be separately recognized only if such an asset meets the contractual-legal criterion or the separability criterion. The implementation of SFAS No. 141 did not have a material impact on our results of operations or financial position. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," under which goodwill and intangible assets with indefinite useful lives are no longer amortized but will be reviewed for impairment annually, or more 22 frequently if certain events or changes in circumstances indicate that the carrying value may not be recoverable. The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. Intangible assets with finite useful lives will continue to be amortized over their useful lives and will be reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The implementation of SFAS No. 142 at did not have a material impact on our results of operations or financial position. In August 2001, the FASB issued SFAS No. 144, that supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and certain provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 retains the fundamental provisions of SFAS No. 121 related to: (i) the recognition and measurement of the impairment of long-lived assets to be held and used, and (ii) the measurement of long-lived assets to be disposed by sale. It provides more guidance on estimating cash flows when performing recoverability tests, requires long-lived assets to be disposed of other than by sale to be classified as held and used until disposal, and establishes more restrictive criteria to classify long-lived assets as held for sale. In addition, SFAS No. 144 supersedes the accounting and reporting provisions of APB Opinion No. 30 for the disposal of a segment of a business. However, it retains the basic provisions of APB Opinion No. 30 to report discontinued operations separately from continuing operations and extends the reporting of a discontinued operation to a component of an entity. The implementation of SFAS No. 144 did not have a material impact on our results of operations or financial position. We have evaluated the carrying value of long-lived assets, including associated intangibles. We performed an evaluation of recoverability by comparing the estimated future undiscounted cash flows associated with the asset to the asset's carrying amount to determine if a write-down to market value or discounted cash flow is required. Given the homogeneous nature and geographic deployment flexibility of our assets, and based upon a recent evaluation by us, impairment of our long-lived assets has not been deemed necessary. However, there can be no assurances that our ongoing evaluation would not result in an impairment-related write-down. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," that addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires companies to recognize costs associated with exit or disposal 23 activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. In addition, SFAS No. 146 establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002, but early adoption is permitted. We do SFAS No 146 to have a significant impact on our financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based Compensation", that amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No. 28, "Interim Financial Reporting", to require disclosure of those effects in interim financial statements. SFAS No. 148 is effective for fiscal years ended after December 15, 2002, but early adoption is permitted. We will adopt SFAS No. 148 on January 1, 2003; however, we do not expect the adoption to have a significant impact on our financial reporting because we do not use stock based compensation extensively. RECENT EVENTS In January 2003 we signed a contract to process various waste streams for Rineco Chemical Industries, Inc., an entity related to Rineco Recycling, LLC. In March 2003 we obtained a loan of $1,500,000 from Rineco Recycling, LLC. The loan is to be funded in three $500,000 fundings (less $40,000 in origination fees per funding) on March 20, 2003 (we have already received this funding tranch); May 15, 2003; and August 15, 2003. The loan is collateralized by three of our ITD units and bears interest at a stated rate of 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. We issued 1,500,000 warrants to purchase shares of our common stock at an exercise price of $0.01 per share in connection with this loan and these warrants were valued at $345,000. The loan origination fees and warrants results in an effective interest rate on the loan of approximately 35% per year. This transaction made Rineco Recycling, LLC a related party and the beneficial owner of 13% of our common stock, although none of the warrants have been exercised. Also during March 2003, we extended the maturity date of the uncollateralized notes from April 16, 2003 to September 16, 2003. ACCOUNTING ESTIMATES AND CHOICES Preparation of financial statements under generally accepted accounting principles in the United States of America requires us to make choices between acceptable methods of accounting and to make estimates of future events to determine the value we report for certain assets and liabilities at the date of our financial statements and the value we report for revenues and expenses in a period covered by our financial statements. While we try to be as precise as possible in making these estimates, many of them are subjective in nature and involve matters of judgment. We believe the most subjective and material estimates in our financial statements are the reserve, if any, that we report for accounts receivable, the amount of our deferred taxes and our accrued warranty costs. 24 Accounts Receivable. When an account receivable is considered impaired, the amount of the impairment is measured based on the present value of expected future cash flows or the fair value of collateral. Impairment losses (recoveries) are included in the allowance for doubtful accounts. Deferred Taxes. We record a valuation allowance to reduce our deferred income tax assets to an amount that we believe to be realizable under the "more-likely-than-not" recognition criteria. While we consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the future we may change our estimate of the amount of the deferred income tax assets that would "more-likely-than-not" be realized, resulting in an adjustment to the deferred income tax asset valuation allowance that would either increase or decrease, as applicable, reported net income in the period. Accrued Warranty and Other Contingent Costs. We record an accrual for product warranty and other contingencies when estimated future expenditures associated with such contingencies become probable, and the amounts can reasonably be estimated. However, new information may become available, or circumstances (such as applicable laws and regulations) may change, thereby resulting in an increase or decrease in the amount required to be accrued for such matters (and therefore a decrease or increase in reported net income in the period of such change). We believe that all of the estimates we used to prepare our financial statements were reasonable at the time we made them, but circumstances may change requiring us to revise our estimates in ways that could have a material adverse impact on our results of operations or financial position. BUSINESS INTRODUCTION We are engaged in the development, production and sale of environmental remediation and recycling technologies and services to oil and gas industry participants, waste management companies and other industrial customers, through our wholly-owned subsidiaries National Fuel & Energy, Inc. ("NFE") and OnSite Technology, L.L.C. ("OnSite"). During the period from 1996 until 2000 a substantial portion of our revenues were generated from major international oil and gas industry participants in Latin America (Colombia, Venezuela and Mexico) as well as from other domestic and foreign industrial applications. As of April 2003 we have completed our foreign contract operations, and have taken steps to close down certain of our foreign subsidiaries. We are now concentrating our marketing efforts and resources on domestic downstream plants, manufacturing facilities and waste management facilities, where our proprietary equipment and process have a competitive advantage in waste minimization, and recycling/reuse of waste streams. As of April 2003, OnSite operates internationally through its wholly-owned subsidiary OST Equipment Leasing L.L.C, and its 50%-owned subsidiary, OnSite Arabia, Inc. OnSite is in the process of closing down (liquidating) the OnSite Colombia, Inc. and OnSite Mexico, L.L.C. subsidiaries. Onsite has completely closed down its OnSite Venezuela, Inc. and OnSite Environmental UK Ltd. subsidiaries. 25 The environmental remediation and recycling services that we provide involve the removal of hydrocarbon contaminants from solids using indirect thermal desorption remediation and recycling technology. We provide these services on-site or at the central location to which the customer hauls the contaminated materials. HISTORY We were incorporated under the laws of the State of Nevada in December 1985, under the name of Cape Cod Investment Company. In December 1986, our name was changed to Cape Cod Ventures, Inc. In August 1987, an initial public offering was completed for 4,148,000 shares of common stock at a price of $0.001 per share pursuant to the exemption from the registration requirements of the Securities Act of 1933 provided by Regulation A. In May 1993, an Agreement and Plan of Reorganization was executed with National Fuel & Energy, Inc., a Wyoming corporation, providing for the acquisition of NFE in exchange for shares of our common stock. In connection with the reorganization, our name was changed to Environmental Safeguards, Inc., and NFE became our wholly-owned subsidiary. In January 1995, we entered into an agreement with Parker Drilling Company ("Parker"), a Delaware corporation, granting Parker exclusive marketing rights to our proprietary processes for on-site remediation and recycling services in connection with drill cuttings at oil and gas drilling sites throughout the United States and in certain foreign countries. In August 1995, we expanded our agreement with Parker by forming OnSite, a joint company between NFE and Parker, in which NFE and Parker each owned 50%. In December 1997, we entered into a Purchase Agreement (the "Purchase Agreement") with Parker that provided for our acquisition, through NFE, of Parker's 50% equity interest in OnSite resulting in NFE becoming the owner of 100% of the equity interest in OnSite. Pursuant to the terms of the Purchase Agreement, we paid $8,000,000 for the 50% equity interest and repaid a $3,000,000 loan that had been made to us by an affiliate of Parker. As part of the transaction, Parker returned to us unexercised warrants to purchase 300,000 shares of our common stock. Our sources of funds to effect the acquisition included the sale of $8,000,000 of new Series B Convertible Preferred Stock and Series C Preferred Stock to an investor group consisting of Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone, who is the Chairman of Stone Energy Corporation and a secured loan of $6,000,000 from the same investor group ("Loan Agreement"). Pursuant to the financing, David L. Warnock, a member of Cahill, Warnock & Co., L.L.C. and general partner of Cahill, Warnock Strategic Partners Fund, L.P., was appointed as one of our Directors. BUSINESS ACTIVITIES General: Substantially all of our activities are conducted through OnSite, which is engaged in the development and production of remediation and recycling technology and the sale of environmental remediation and recycling services. 26 OnSite owns the technologies included in its Indirect Thermal Desorption ("ITD") units, and the proprietary processes for on-site remediation and recycling of hydrocarbon contaminated solids. To date, the environmental remediation and recycling services we have provided have involved the removal of petroleum contaminants from waste streams using our ITD units. Our ITD units are easily transported processing systems which produce clean solids from contaminated solids while reclaiming the hydrocarbons. Our customers consist primarily of large corporations with hydrocarbon or hydrocarbon derivative contaminated waste streams and waste management companies in the business of offering waste disposal services. The primary services we offer involve the remediation and recycling of waste streams contaminated by oil-based drilling fluids, fuel spills, leakage at storage tanks, refinery wastes, ship sludges and other sources of hydrocarbon contamination, as well as the remediation of industrial waste. To remediate and recycle the contaminated solids, we utilize our ITD units consisting of (i) an indirect thermal desorption unit wherein the hydrocarbon contaminated materials are indirectly heated, thereby causing the hydrocarbon contamination to vaporize; and (ii) a condensation process system, which causes the hydrocarbon vapor to condense to a liquid, or an afterburner or thermal oxidizer, which incinerates the hydrocarbon vapor resulting in a safe and clean process. Our ITD units are mobile, and thus, contaminated solids can be remediated and recycled at the site where the contaminated waste streams are located. We do not haul or dispose of solids or contaminants away from the customer's location. As of April 2003, we owned five ITD units outright, and had a 50% interest in two additional units owned by our 50%-owned subsidiary OnSite Arabia, Inc. Customers: Our targeted customers are companies that have industrial activities or sites that produce or process quantities of hydrocarbon contaminated waste. Through OnSite, we typically submit a bid for a project based on the costs of moving the equipment to the location, the estimated charges for labor and fuel, the nature and extent of the contamination, the type and moisture content of the soil and the estimated processing time. Once a contract has been awarded, equipment is moved to the client's desired location. Indirect Thermal Remediation and Recycling: The primary services we offer involve: (i) the remediation and recycling of hydrocarbon contaminated industrial waste streams, (ii) the remediation and recycling of hydrocarbon contamination at settling ponds, oil and gas exploration sites, refineries, petrochemical facilities, abandoned production fields, Department of Defense installations, ships and dock facilities and other similar sites; (iii) the remediation and recycling of soil contaminated by oil-based drilling mud, fuel spills, leakage at storage tanks, leakage from pipelines; and (iv) the remediation and recycling of valuable drilling fluids which have been captured in soil and drilling muds during the drilling process. To date we have employed our ITD units to provide remediation and recycling services to oil and gas industry refining and drilling operations, tank farms and compressor sites, industrial waste disposal facilities and oilfield waste disposal facilities. This process is known as "indirect thermal desorption" because it reverses the contamination process and removes the hydrocarbons from the solids and discharges the contaminants previously absorbed without direct contact of the solid to a flame. 27 Our ITD units, which are portable equipment, utilize a rotating, heat-jacketed trundle to vaporize hydrocarbons from contaminated soil or other contaminated materials. Our ITD units consist of two principal components: (i) an indirect thermal desorption unit wherein the hydrocarbon contaminated solid is indirectly heated, thereby causing the hydrocarbon contamination to vaporize; and (ii) a condensation process system, which causes the hydrocarbon vapor to condense to a liquid for recycling. As an alternative to the condensing system, the vapor can be passed through an afterburner or thermal oxidizer, which incinerates the hydrocarbon vapors. The heat exchange system is comprised of a large fabricated steel shell which houses a rotating trundle. Hot gases pass through the shell and around the outside surface of the trundle. Hydrocarbon contaminated materials, are loaded into the elevated end of the trundle by a conveyor belt or a front-end loader. As the trundle revolves, the contaminated materials are agitated by internal lifts and oars as they passes through the inside of the trundle by gravity flow and are heated to temperatures from 200 to 1,000 degrees Fahrenheit. At these temperatures, the hydrocarbon contaminants in the solids transform into vapors, which are vacuumed out of the heat exchange system into the condensing system, the afterburner or the thermal oxidizer. The clean materials then drop out of the discharge door at the low end of the trundle and are passed through an enclosed conveyor for re-hydration before final discharge. Random samples are tested at the end of the process to confirm that the contaminants have been removed. The hydrocarbon vapors removed from the heat exchange system by vacuum are passed through a fan-cooled condensing system. The vapors are condensed into liquids and collected in storage tanks and can then be recycled or disposed, depending on the nature of the contaminant, the needs of the customer and the specifications required for reuse. To date, our ITD units have demonstrated their ability to process up to 192 tons of contaminated soil in a 24-hour period with 30% hydrocarbon saturation. However, the processing capacity varies significantly depending on the moisture content, degree of contamination, soil type, contamination type and the remediation and recycling required. There can be no assurance that our ITD units will continue to perform at this level, or that this performance will continue to be competitive with other technologies available in the market. Recycling of Hydrocarbon Contaminants: We have developed proprietary processes that are embodied in the condensation process system unit, one of the two principal components of our ITD units. Within this component the hydrocarbon contaminants are condensed from the vapor state created in the heat exchange unit back into a liquid state via the proprietary processes and placed into storage for recycling back to the client. This allows the client to realize actual savings from its ability to re-utilize the hydrocarbons. We believe that this ability to recycle the hydrocarbon contaminants is an important competitive advantage, as compared to the bioremediation, direct burn or "dig and haul" remediation technologies. Manufacturing of ITD Units: We have historically contracted with outside fabricators to manufacture our ITD units. The primary contractors we have used are National Oilwell and Houston ProFab. As of April 21, 2003, we did not have any ITD units under construction, nor did we have plans to fabricate additional ITD Units. 28 RECENT EVENTS In January 2003 we signed a contract to process various waste streams for Rineco Chemical Industries, Inc., an entity related to Rineco Recycling, LLC. (The selling security holder). In March 2003 we obtained a loan of $1,500,000 from Rineco Recycling, LLC. The loan is to be funded in three $500,000 fundings (less $40,000 in origination fees per funding) on March 20, 2003 (we have already received this funding tranch); May 15, 2003; and August 15, 2003. The loan is collateralized by three of our ITD units and bears interest at a stated rate of 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. We issued 1,500,000 warrants to purchase shares of our common stock at an exercise price of $0.01 per share in connection with this loan and these warrants were valued at $345,000. The loan origination fees and warrants results in an effective interest rate on the loan of approximately 35% per year. This transaction made Rineco Recycling, LLC a related party and the beneficial owner of 13% of our common stock, although none of the warrants have been exercised. Also, during March 2003, we extended the maturity date of the uncollateralized loans from April 16, 2003 to September 16, 2003. We operate with our own trained personnel through wholly or partially-owned subsidiaries as discussed above. As of April 2003, five of our ITD units are located in the United States and two in the United Arab Emirates. COMPETITION There are many companies that currently dispose of hazardous and industrial wastes and remediate or clean contaminated sites. Such companies are continually attempting to develop new and improved products and services. Other companies utilize competing technologies and techniques in an attempt to provide more economical or superior remediation services. Many of our competitors are established companies with substantially greater capital resources, larger research and development staffs and facilities and greater marketing capabilities than us. There can be no assurance that we will be competitive in the remediation and recycling industry in the future. We obtain our contracts through competitive bidding and are in direct competition with companies providing alternative means of, and utilizing alternative technologies for, remediating environmental problems. The most significant competition comes from companies utilizing "dig and haul," direct burn, and bioremediation technology to remediate hydrocarbon contamination. Companies utilizing the "dig and haul" method generally transport the contaminated materials to other facilities for processing. We believe that the technology we utilize is competitive because our equipment is mobile, and thus, contaminated materials can be remediated on location. The waste processing, remediation and recycling businesses are, to a large extent, dependent upon and constrained by the costs and regulations associated with transporting such wastes. More importantly, our remediation and recycling process addresses the latent liability associated with the contamination at the site. 29 Companies utilizing direct burn technology use direct heat sources to incinerate contaminants found in the solids. Due to the closed nature of the heat transfer systems of our ITD units, we can safely handle much higher concentrations of contaminants than conventional direct burn methods. Conventional direct burn methods process material with maximum contamination levels of 3% to 4% while our ITD units have processed materials with contamination levels as high as 40%. In addition, the portable nature of our ITD units permit them to be located at the contamination site. Our ITD units also permit the customer to recapture certain valuable liquids which are otherwise destroyed. We differentiate ourselves from our competitors by providing significantly higher operational service and a significantly higher value-added result for our clients for the remediation of hydrocarbons from materials, and the subsequent reclaiming of the hydrocarbons into liquids for customer recycling or resale. For example, some of the design features of our ITD unit, which we believe provide service-level advantages, include: Remediation: Our ITD units remove 99.9% of hydrocarbon contaminants from the waste-stream, effectively eliminating the client's latent liability. Recycling: Our ITD units transform waste streams into value for our clients by reclaiming valuable hydrocarbons for client recycling or resale. For example, our equipment has reclaimed millions of gallons of diesel oil while processing drill cuttings for major oil and gas participants. Tonnage: Our ITD units have proven processing capability of 1 to 10 tons per hour with up to 30% hydrocarbon-saturation in the soil. Some competitors are capable of similar processing speeds, but at lower hydrocarbon-saturation levels, resulting in throughput advantages for us. Portability: Our ITD units are built on two 44 foot trailer beds for easier transport to our client's location, avoiding costly hauling expenses of contaminated materials to a central location. In addition, the design of our ITD units permit rig-down and/or rig-up in less than a day. Some competitive units are much less transportable, or not transportable at all. Wide Range of Hydrocarbons Treated: Our ITD units operate at low temperatures (200 degrees Fahrenheit), high temperatures (1,000 degrees Fahrenheit), and anywhere in between, thereby enabling the remediation of wide ranges of hydrocarbon contaminants encountered at a client's site including both oil and gas and industrial waste. We believe that competition in the industry is concentrated in remediation services, whereas our ITD technology not only provides remediation services, but also is capable of reclaiming and recycling valuable hydrocarbons. Further, we believe that our pricing policies are competitive. No assurance, however, can be given that we will be able to successfully compete with other companies or alternative technologies. 30 GOVERNMENTAL REGULATIONS AND THE COST OF COMPLIANCE We render services in connection with the remediation, recycling and disposal of various wastes. Federal, state and local laws and regulations have been enacted regulating the handling and disposal of wastes and creating liability for certain environmental contamination caused by such waste. Environmental laws regulate, among other things, the transportation, storage, handling and disposal of waste. Governmental regulations govern matters such as the disposal of residual chemical wastes, operating procedures, waste water discharges, air emissions, fire protection, worker and community right-to-know, and emergency response plans. Moreover, so-called "toxic tort" litigation has increased markedly in recent years as persons allegedly injured by chemical contamination seek recovery for personal injuries or property damage. These legal developments present a risk of liability should we be deemed to be responsible for contamination or pollution caused or increased by any evaluation, remediation or cleanup effort conducted by us, or for an accident which occurs in the course of such remediation or cleanup effort. There can be no assurance that our policy of establishing and implementing proper procedures for complying with environmental regulations will be effective at preventing us from incurring a substantial environmental liability. If we were to incur a substantial uninsured liability for environmental damage, our financial condition could be materially adversely affected. We presently have the ability to deliver remediation and recycling services that meet applicable federal and state standards for the delivery of our services, and for the level of contaminant removal. The government can, however, impose new standards. If new regulations were to be imposed, we may not be able to comply in either the delivery of our services, or in the level of contaminant removal from the waste stream. Operating permits are generally required by federal and state environmental agencies for the operation of our ITD units. Most of these permits must be renewed periodically and the governmental authorities involved have the power, under various circumstances, to revoke, modify, or deny issuance or renewal of these permits. Site-related permits, however, are generally the responsibility of the client. EMPLOYEES We currently have 15 employees, five of whom are in domestic and international management or supervisory positions, including corporate and administrative functions. None of our employees are represented by a union. We consider our employee relations to be good. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is Colonial Stock Transfer Company, Inc., addressed at 66 Exchange Place, Salt Lake City, Utah 84111; (801) 355-5740. 31 PROPERTIES Our principal executive offices are located in leased facilities at 2600 South Loop West, Suite 645, Houston, Texas 77054, which consist of 3,852 square feet. The lease for the executive offices will expire in May 2003. We believe that our offices are adequate for our present needs and that suitable space will be available to accommodate our future needs. For information relating to our properties, reference is made to Financial Note 6 to our audited Financial Statements for the year ended December 31, 2002 under the subsection "Lease Commitments." These Financial statements begin on page F-1. MANAGEMENT The following table sets forth the names and positions of each of our executive officers and directors:
Name Age Position ------------------- --- ----------------------------------------------- James S. Percell 59 Director, Chairman, Chief Executive Officer and President Thomas R. Bray 47 Director Bryan Sharp 59 Director Albert M. Wolford 81 Director David L. Warnock 45 Director Michael D. Thompson 51 Chief Financial Officer
Directors are elected annually and hold office until the next annual meeting of our stockholders or until their successors are elected and qualified. Officers are elected annually and serve at the discretion of the Board of Directors. There is no family relationship between or among any of our directors and executive officers. Board vacancies are filled by a majority vote of the Board. James S. Percell serves as Director, Chairman, Chief Executive Officer and President and also serves as President of our subsidiaries, National Fuel & Energy, Inc. ("NFE") and OnSite Technology LLC ("OnSite"). Mr. Percell became a director and President, Chief Executive Officer and a director of NFE in November 1995. Mr. Percell became President and Chief Executive Officer of our consolidated company in January 1996. Mr. Percell also serves as President of Percell & Associates, a project developer of facilities in the hydrocarbon industry. From 1985-1993, Mr. Percell served as Vice-President of Belmont Constructors, Inc., a heavy industrial contractor. From 1982-1984, he served as President of Capital Services Unlimited, an international supply company for refining, petrochemical and oil field compressor stations, modular refineries and modular oilfield components. From 1977-1980, Mr. Percell served as President of Percell & Lowder, Inc., an oilfield fabricator of onshore and offshore facilities, and from 1960-1977, he served as project manager for various onshore and offshore projects. He attended Amarillo College in Amarillo, Texas. 32 Thomas R. Bray was appointed as Director in January 2002. Mr. Bray is a member of our compensation and audit committees. Mr. Bray has been a practicing attorney practicing in Stafford and Houston, Texas for the past nine years, specializing in business and real estate transactions, and litigation and general corporate representation, largely for businesses and individuals in the oil and gas services, banking and investment industries. Prior to that, he was vice president of New First City, Texas-Houston, N.A., having previously served as special assistant to the president and an in-house counsel of Collecting Bank, N.A., and vice-president of First City Asset Servicing Company and First City, Texas-Houston, N.A. Mr. Bray has also served as president of Associated Title Company, president of Arbor Oaks Utilities, Inc. a private water and sewer utility company, and the owner and president of Rembrandt Homes, Inc., all in Houston. Mr. Bray graduated from the University of Texas with a BBA in Finance, and received his J.D. degree from South Texas College of Law in Houston. Bryan Sharp has served as a Director since November 1995. Mr. Sharp previously served on our audit committee, and previously was a self-employed environmental consultant. Mr. Sharp previously served as Principal-in-Charge and Director of Espey, Huston & Associates, Inc. ("EH&A"), an environmental consulting company. From 1990-1993, he served as President of EH&A. Mr. Sharp has also been employed by North Texas State University, the Department of the Interior, and the University of Texas. Mr. Sharp has a B.S. degree in Education from North Texas State University, a M.S. degree in Biology from North Texas State University and studied for his Ph.D. in Zoology from The University of Texas at Austin. Albert M. Wolford has served as Director since August 5,1997. Mr. Wolford is a member of our compensation and audit committees, and previously served as our Secretary. Mr. Wolford has been an independent business consultant since 1988. From 1970 to 1988, Mr. Wolford served with Texas United Corporation as a director, a member of the executive committee, senior vice-president, and as the chairman of the executive development and compensation committees. As a senior vice-president of Texas United Corporation, Mr. Wolford served its subsidiaries as president and CEO of Texas United Chemical Corporation, as the chairman, president and CEO of United Salt Corporation, and as the president of American Borate Corporation. He has also served the Texas Chemical Council, an industry trade group, as a director, a member of its executive committee, and as secretary-treasurer. Mr. Wolford served as a member of the executive committee of the Salt Institute, an industry trade group. Mr. Wolford is a graduate of The University of Texas. David L. Warnock was appointed as Director in December 1997 in connection with the December, 1997 financing. Mr. Warnock is a member of our audit and compensation committees. Mr. Warnock is a founding partner of Cahill, Warnock & Company, L.L.C., an asset management firm established in 1995 to invest in small public companies. From 1983 to 1995, Mr. Warnock was with T. Rowe Price Associates in senior management positions including President of the corporate general partner of T. Rowe Price Strategic Partners I and T. Rowe Price Strategic Partners II, and as the Executive Vice-president of T. Rowe Price New 33 Horizons Fund. Mr. Warnock also serves on the Boards of Directors of other public and private companies. Mr. Warnock received a Bachelor of Arts Degree, History, from the University of Delaware and a Masters Degree, Finance, from the University of Wisconsin. Michael D. Thompson became our Chief Financial Officer in September 2002. Beginning in 1997, Mr. Thompson served as Chief Operating Officer of Outsourcing Services, Inc., an accounting and consulting firm where he provided financial and accounting services to clients in a variety of industries. From 1990 through 1996, Mr. Thompson was Chief Financial Officer of The Hanover Company, a fully integrated national real estate development firm. Mr. Thompson is a certified public accountant. Mr. Thompson has a B.B.A. degree with honors from the University of Texas. LIMITATION ON DIRECTORS' LIABILITY; INDEMNIFICATION Our Articles of Incorporation (the "Articles") provide, as permitted by governing Nevada law, that our directors shall not be personally liable to us or any of our stockholders for monetary damages for breach of fiduciary duty as a director, with certain exceptions. The Articles further provide that we will indemnify our directors and officers against expenses and liabilities they incur to defend, settle, or satisfy any civil litigation or criminal action brought against them on account of their being or having been our directors or officers unless, in such action, they are adjudged to have acted with gross negligence or willful misconduct. The inclusion of these provisions in the Articles may have the effect of reducing the likelihood of derivative litigation against directors, and may discourage or deter stockholders or management from bringing a lawsuit against directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders. The Articles provide for the indemnification of our executive officers and directors, and the advancement to them of expenses in connection with any proceedings and claims, to the fullest extent permitted by Nevada law. The Articles include related provisions meant to facilitate the indemnities' receipt of such benefits. These provisions cover, among other things: (i) specification of the method of determining entitlement to indemnification and the selection of independent counsel that will in some cases make such determination, (ii) specification of certain time periods by which certain payments or determinations must be made and actions must be taken, and (iii) the establishment of certain presumptions in favor of an indemnitee. Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Commission, such indemnification is against public policy as expressed in the Act and is therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by a small business issuer of expenses incurred or paid by a director, officer or controlling person of the small business issuer in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being 34 registered, the small business issuer will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. EXECUTIVE COMPENSATION DIRECTOR COMPENSATION We do not currently pay any cash director's fees. However, we pay the expenses, if any, of our directors in attending board meetings. In 1998, our board adopted a stock option plan (as detailed below) that included participation in the plan by directors. EXECUTIVE COMPENSATION Mr. James Percell became Chief Executive Officer in January 1996. Our employment contract with Mr. Percell (the "Employment Agreement"), which commenced in April 1997, has a term of three years. The Employment Agreement automatically extends, unless terminated by us or Mr. Percell (upon at least thirty days written notice prior to the end of the initial term or any additional one-year term), for additional successive one year periods after the initial three year term. Mr. Percell's employment contract provides that he receive annual compensation in the amount of $125,000. In November 1997, the Board of Directors increased Mr. Percell's annual compensation to $250,000, however, during 1998 Mr. Percell agreed to reduce his annual compensation to $180,000. During the year ended December 31, 2002, Mr. Percell agreed to defer and accrue his compensation, beginning with the pay period ended June 15, 2002.
SUMMARY COMPENSATION TABLE LONG TERM COMPENSATION ANNUAL COMPENSATION PAYOUTS OTHER AWARDS SECURITIES ALL NAME AND ANNUAL RESTRICTED UNDERLYING OTHER PRINCIPAL COMPEN- STOCK OPTIONS/ LTIP COMPEN- POSITION YEAR SALARY BONUS SATION AWARDS SARS PAYOUTS SATION James S. Percell 2002 $180,000 -0- -0- -0- -0- -0- -0- CHIEF 2001 $180,000 -0- -0- -0- -0- -0- -0- EXECUTIVE 2000 $180,000 -0- -0- -0- ---0--- -0- -0- OFFICER
OPTION/SAR GRANTS IN LAST FISCAL YEAR NAME AND NUMBER OF PERCENT OF POTENTIAL REALIZ ABLE VALUE AT PRINCIPAL SECURITIES TOTAL ASSUMED ANN UAL RATES OF POSITION UNDERLYING OPTIONS/SARS STOCK PRICE APPRECIATION FOR OPTIONS/SARS GRANTED TO OPTION TERM: GRANTED (1) EMPLOYEES IN FISCAL EXERCISE OF EXPIRATION YEAR BASE PRICE DATE 5% 10% --------------- (1) No Options/SAR Grants made during 2002
35
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY NAME AND SHARES OPTIONS/SARS AT OPTIONS/SARS AT PRINCIPAL ACQUIRED ON VALUE FISCAL YEAR-END FISCAL YEAR-END POSITION EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE James S. Percell (*) (*) -0- / 1,303,042/0 -0- / -0- CHIEF EXECUTIVE OFFICER
--------------- (*) Did not exercise any options. Other than our 1998 Stock Option Plan (described immediately below), we do not have any long term incentive plans or defined benefit or actuarial plans. 1998 STOCK OPTION PLAN While we have been successful in attracting and retaining qualified personnel, we believe that our future success will depend in part on its continued ability to attract and retain highly qualified personnel. We pay wages and salaries that we believe are competitive. We also believe that equity ownership is an important factor in our ability to attract and retain skilled personnel, and on December 9, 1998, the Board of Directors approved the 1998 Stock Option Plan (the "Plan") which was approved by the Stockholders at our 1999 annual meeting of stockholders. The Plan will allow Incentive Stock Options as determined by the Compensation Committee, or the Board of Directors if there is no compensation committee (the "Committee"). In 1998, the Board of Directors has reserved 800,000 shares of Common Stock for issuance pursuant to the Plan. The purpose of the Plan is to foster and promote our financial success and increase stockholder value by enabling eligible key employees, directors and consultants to participate in our long-term growth and financial success of the Company. In April 2003, our Board of Directors approved increasing the number of shares for issuance pursuant to the Plan to 1,600,000 shares. This change is subject to the approval of our Shareholders and will be voted on at our annual meeting on May 22, 2003. If our shareholders approve the increase, then the new options in the Plan will qualify as either Incentive Stock Options or Non-qualified stock options. ELIGIBILITY. The Plan is open to key employees (including officers and directors) and our consultants and affiliates ("Eligible Persons"). TRANSFERABILITY. The grants are not transferrable. CHANGES IN CAPITAL STRUCTURE. The Plan will not effect our right to authorize adjustments, recapitalizations, reorganizations or other changes in our capital structure. In the event of an adjustment, recapitalization or reorganization the award shall be adjusted accordingly. In the event of a merger, consolidation, or liquidation, the Eligible Person will be eligible to receive a like number of shares of stock in the new entity. The board may waive any limitations imposed under the Plan so that all options are immediately exercisable. 36 OPTIONS. The Plan provides for both Incentive and Nonqualified Stock Options. Option price. Incentive options shall be not less than the greater of (i) 100% of fair market value on the date of grant, or (ii) the aggregate par value of the shares of stock on the date of grant. The Compensation Committee, at its option, may provide for a price greater than 100% of fair market value. The price for Incentive Stock Options for Stockholders owning 10% or more of our shares ("10% Stockholders") shall be not less than 110% of fair market value. Amount exercisable-incentive options. In the event an Eligible Person exercises incentive options during the calendar year whose aggregate fair market value exceeds $100,000, the exercise of options over $100,000 will be considered nonqualified stock options. Duration. No option may be exercisable after the expiration date as set forth in the option agreement. Exercise of Options. Options may be exercised by written notice to our President with: (i) cash, certified check, bank draft, or postal or express money order payable to Environmental Safeguards, Inc. for an amount equal to the option price of the shares; (ii) stock at its fair market value on the date of exercise; (iii) an election to make a cashless exercise through a registered broker-dealer (if approved in advance by the Compensation Committee); (iv) an election to have shares of stock, which otherwise would be issued on exercise, withheld in payment of the exercise price (if approved in advance by the Compensation Committee); and/or (v) any other form of payment which is acceptable to the Compensation Committee, including without limitation, payment in the form of a promissory note, and specifying the address to which the certificates for the shares are to be mailed. TERMINATION OF OPTIONS. Termination of Employment. Any Option which has not vested at the time the Optionee ceases continuous employment for any reason other than death, disability or retirement shall terminate upon the last day that the Optionee is employed by us. Incentive Stock Options must be exercised within three months of cessation of Continuous Service for reasons other than death, disability or retirement in order to qualify for Incentive Stock Option tax treatment. Nonqualified Options may be exercised any time during the Option Period regardless of employment status. 37 Death. Unless the Option expires sooner, the Option will expire one year after the death of the Eligible Person. Disability. Unless the Option expires sooner, the Option will expire one year after the disability of the Eligible Person. Retirement. Any Option which has not vested at the time the Optionee ceases continuous employment due to retirement shall terminate upon the last day that the Optionee is employed by us. Upon retirement Incentive Stock Options must be exercised within three months of cessation of Continuous Service in order to qualify for Incentive Stock Option tax treatment. Nonqualified Options may be exercised any time during the Option Period regardless of employment status. AMENDMENT OR TERMINATION OF THE PLAN. The Committee may amend, terminate or suspend the Plan at any time, in its sole and absolute discretion; provided, however, that to the extent required to qualify the Plan under Rule 16b-3 promulgated under Section 16 of the Exchange Act, no amendment that would (a) materially increase the number of shares of stock that may be issued under the Plan, (b) materially modify the requirements as to eligibility for participation in the Plan, or (c) otherwise materially increase the benefits accruing to participants under the Plan, shall be made without the approval of our Stockholders; provided further, however, that to the extent required to maintain the status of any incentive option under the Code, no amendment that would (a) change the aggregate number of shares of stock which may be issued under incentive options, (b) change the class of employees eligible to receive incentive options, or (c) decrease the option price for incentive options below the fair market value of the stock at the time it is granted, shall be made without the approval of the Stockholders. Subject to the preceding sentence, the Board shall have the power to make any changes in the Plan and in the regulations and administrative provisions under it or in any outstanding incentive option as in the opinion of our counsel may be necessary or appropriate from time to time to enable any incentive option granted under this Plan to continue to qualify as an incentive stock option or such other stock option as may be defined under the Code so as to receive preferential federal income tax treatment. No amendment, suspension or termination of the Plan shall act to impair or extinguish rights in Options already granted at the date of such amendment, suspension or termination. OPTIONS GRANTED UNDER 1998 STOCK OPTION PLAN The following sets forth the options granted under our 1998 Stock Option Plan: NAME AND POSITION DOLLAR NUMBER OF ---------------------------- --------- --------- VALUE(1) OPTIONS --------- --------- James S. Percell, CEO $ 210,937 125,000 Executive Group(2) $ 215,137 145,000 Non-executive Director Group $ 126,450 180,000 Non-executive Officer Employee Group $ 624,320 422,500 Total $957,907 747,500 38 --------------- (1) Dollar value was calculated based on the exercise price of $1.6875 for the options granted in December 1998 and $0.21 for the options granted in March 2003. These exercise prices were the market value per share on the date of the grants. (2) Amounts include dollar value and options granted to Mr. Percell. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Our Board of Directors has adopted a policy that our affairs will be conducted in all respects by standards applicable to publicly-held corporations and that we will not enter into any transactions and/or loans between us and our officers, directors and 5% stockholders unless the terms are no less favorable than could be obtained from independent, third parties and will be approved by a majority of our independent, disinterested directors. In January 2003 we signed a contract to process various waste streams for Rineco Chemical Industries, Inc., an entity related to Rineco Rcycling, LLC. In March 2003 we obtained a loan of $1,500,000 from Rineco Recycling, LLC. The loan is to be funded in three $500,000 fundings on March 20, 2003 (we have already received this funding tranch); May 15, 2003; and August 15, 2003. The loan is collateralized by three of our ITD units and bears interest at 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. We issued 1,500,000 warrants to purchase shares of our common stock at an exercise price of $0.01 per share in connection with this loan. This transaction made Rineco Recycling, LLC the beneficial owner of 13% of our common stock, although none of the warrants have been exercised as of April 25, 2003. In July 2002, we obtained uncollateralized loans totaling $250,000 from Cahill Warnock Strategic Partners, L.P. and Strategic Associates, L.P. These loans bear interest of 12% per year and were originally due in January 2003 but have been extended to September 2003. David L. Warnock, one of our Directors, is a general partner of Cahill Warnock Strategic Partners, L.P. and a managing member of the general partner of Strategic Associates, L.P. In March 2001 and September 2000, we entered into agreements with our primary lenders and holders of our outstanding preferred stock to defer various principal and interest payments on our senior debt. The senior debt was fully repaid in December 2001. 39 During 1998, we entered into a marketing assistance agreement with the minority owners of OnSite Colombia, Inc. Under the terms of the agreement, in exchange for assisting us in our business expansion efforts, the minority owners and we each received marketing assistance fees totaling $320,000 during each of the years ended December 31, 2000 and 1999. During December 1998, we formed a joint company, OnSite Arabia, Inc. with an investor group for the purpose of providing environmental remediation in the Arabian gulf region. We sold two ITD units to the newly formed joint company (one in 1999 and one in 1998) and recognized gains to the extent proceeds received exceeded our proportional basis in the assets. 40 PRINCIPAL STOCKHOLDERS The following table sets forth certain information as of April 25, 2003, with respect to the beneficial ownership of shares of common stock by (i) each person who is known by us to beneficially own more than 5% of the outstanding shares of common stock, (ii) each of our directors, (iii) each of our executive officers, and (iv) all executive officers and directors as a group. Unless otherwise indicated, each stockholder has sole voting and investment power with respect to the shares shown.
NUMBER OF PERCENT CLASS OF NAME SHARES OWNED(1) OF CLASS SECURITIES --------------------------------- ------------------------ --------- ------------ James S. Percell 1,486,960 (2) 13.0% Common Stock 2600 South Loop West, Suite 645 Houston, Texas 77054 Bryan Sharp 1,147,264 (3)(9) 10.2% Common Stock 3200 Wilcrest, #200 Houston, Texas 77042 Albert M. Wolford 144,346 (4)(9) 1.4% Common Stock 2600 South Loop West, Suite 645 Houston, Texas 77054 David L. Warnock 8,600,642 (5)(6)(9)(10) 46.0% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Edward L. Cahill 8,565,642 (5)(6) 45.9% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Cahill, Warnock Strategic Partners Fund, L.P 8,565,642 (5)(6) 45.9% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Strategic Associates, L.P. 8,565,642 (5)(6) 45.9% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Cahill, Warnock & Company, L.L.C. 8,565,642 (5)(6) 45.9% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Cahill, Warnock Strategic Partners, L.P. 8,565,642 (5)(6) 45.9% Common Stock One South Street, Suite 2150 Baltimore, Maryland 21202 Thomas R. Bray 15,000 (10) 0.1% Common Stock 2600 South Loop West, Suite 645 Houston, Texas 77054 Newpark Resources, Inc. 7,845,156 (7)(8) 43.7% Common Stock 3850 N. Causeway, Suite 1770 Metairie, LA 70002-1756 Michael D. Thompson 10,000 (11) 0.1% Common Stock 2600 South Loop West, Suite 645 Houston, Texas 77054 Rineco Recycling, LLC 1,500,000 (12) 13% Common Stock 629 Vulcan Road Haskell, Arkansas 72015 All officers and directors as a Group (6 persons) 11,404,212 53.6% Common Stock
41 --------------- (1) Under the rules of the Securities and Exchange Commission (the "Commission"), a person who directly or indirectly has or shares voting power or investment power with respect to a security is considered a beneficial owner of the security. Voting power is the power to vote or direct the voting of shares, and investment power is the power to dispose of or direct the disposition of shares. Shares as to which voting power or investment power may be acquired within 60 days are also considered as beneficially owned under the Commission's rules and are, accordingly, included as shares beneficially owned. (2) Includes an option to purchase 800,000 shares of our common stock at $0.60 per share, and options to purchase 378,042 shares of our common stock at $1.44 per share. Also includes an option to purchase 125,000 shares of our common stock at $1.69 per share. These options are fully vested and immediately exercisable. (3) Includes an option to purchase 800,000 shares of our common stock at $0.60 per share, an option to purchase 301,267 shares of our common stock at $3.00 per share, an option to purchase 10,997 shares of our common stock at $5.00 per share, and an option to purchase 15,000 shares of our common stock at $0.21 per share. These options are fully vested and immediately exercisable. Excludes an option to purchase 15,000 shares of our common stock at $0.21 per share which vests March 6, 2004. (4) Includes options to purchase 43,346 shares of our common stock at $1.44 per share and an option to purchase 15,000 shares of our common stock at $0.21 per share. These options are fully vested and immediately exercisable. Excludes an option to purchase 15,000 shares of our common stock at $0.21 per share which vests March 6, 2004. (5) Includes 1,722,900 shares of Series B Convertible Preferred Stock and warrants to purchase 599,717 shares of our common stock at $0.01 per share issued to Cahill, Warnock Strategic Partners Fund, L.P. ("Cahill Warnock Fund"), whose sole general partner is Cahill, Warnock Strategic Partners, L.P. ("Cahill Warnock Partners"). In addition, includes 95,464 shares of Series B Convertible Preferred Stock and warrants to purchase 33,230 shares of our common stock at $0.01 per share issued to Strategic Associates, L.P. ("Strategic Associates"), whose sole general partner is Cahill, Warnock & Company, L.L.C. ("Cahill Warnock"). Each share of Series B Convertible Preferred Stock is immediately convertible into one share of our common stock, subject to adjustment under certain conditions. The warrant is fully vested and immediately exercisable. David L. Warnock and Edward L. Cahill are the sole general partners of Cahill Warnock Partners and the sole members of Cahill Warnock. David L. Warnock and Edward L. Cahill are control persons of Cahill Warnock Fund, Cahill Warnock Partners, Strategic Associates, and Cahill Warnock. David L. Warnock, Edward L. Cahill, Cahill Warnock Fund, Cahill Warnock Partners, Strategic Associates and Cahill Warnock have shared voting power and shared dispositive power of these shares and each disclaim beneficial ownership of the shares and warrants, except with respect to their pecuniary interest therein, if any. (6) Includes 4,938,703 shares of our common stock which would arise upon the conversion of 182,732 shares of our Series D Convertible Preferred Stock, issued to the Cahill Warnock Fund, whose sole general partner is Cahill Warnock Partners. Also includes 273,649 shares of our common stock which would arise upon the conversion of 10,125 shares of our Series D Convertible Preferred Stock, issued to Strategic Associates, whose sole general partners is Cahill Warnock. Also includes 854,625 shares of common stock issuable to Cahill Warnock Fund and 47,354 shares of common stock issuable to Strategic Associates upon conversion of deferred dividends and interest thereon related to the Series D Preferred Stock. These Preferred shares, deferred dividends and interest are immediately convertible into our common stock. (7) Includes 5,405,405 shares of our common stock which would arise upon the conversion of 200,000 shares of our Series D Convertible Preferred Stock, issued to Newpark Resources, Inc. Also includes 935,386 shares of common stock upon conversion of deferred dividends and interest thereon related to the Series D Preferred Stock. These Preferred shares, deferred dividends and interest are immediately convertible into our common stock. (8) Includes 847,975 shares of Series B Convertible Preferred Stock which are immediately convertible into shares of common stock. The number of shares of common stock into which each share of Preferred Stock may be converted is presently one share of common stock for each share of Series B Convertible Preferred Stock, subject to adjustment under certain conditions. Also includes warrants to purchase 656,390 shares of our common stock at $0.01 per share. The warrant is fully vested and immediately exercisable. (9) Also includes an option to purchase 20,000 shares of our common stock at $1.69 per share. These options are fully vested and immediately exercisable. (10) Includes an option to purchase 15,000 shares of our common stock at $0.21 per share. Excludes an option to purchase 15,000 shares of our common stock at $0.21 per share which vests March 6, 2004. (11) Includes an option to purchase 10,000 shares of our common stock at $0.21 per share. Excludes an option to purchase 10,000 shares of our common stock at $0.21 per share which vests March 6, 2004. 42 (12) Includes common stock underlying 1,500,000 warrants that are immediately exercisable. We know of no arrangement or understanding which may at a subsequent date result in a change of control. PLAN OF DISTRIBUTION The selling stockholder and any of its pledgees, assignees, and successors-in-interest may, from time to time, sell any or all of their shares of common stock on any stock exchange, market, or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. There is no assurance that the selling stockholder will sell any or all of the common stock in this offering. The selling stockholder may use any one or more of the following methods when selling shares: - Ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers. - Block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction. - Purchases by a broker-dealer as principal and resale by the broker-dealer for its own account. - An exchange distribution following the rules of the applicable exchange. - Privately negotiated transactions. - Short sales or sales of shares not previously owned by the seller. - Broker-dealers may agree with the selling stockholder to sell a specified number of such shares at a stipulated price per share. - A combination of any such methods of sale. - Any other lawful method. The selling stockholder may also engage in: - Short selling against the box, which is making a short sale when the seller already owns the shares. - Buying puts, which is a contract whereby the person buying the contract may sell shares at a specified price by a specified date. 43 - Selling calls, which is a contract giving the person buying the contract the right to buy shares at a specified price by a specified date. - Selling under Rule 144 under the Securities Act, if available, rather than under this prospectus. - Other transactions in our securities or in derivatives of our securities and the subsequent sale or delivery of shares by the stock holder. - Pledging shares to their brokers under the margin provisions of customer agreements. If a selling stockholder defaults on a margin loan, the broker may, from time to time, offer and sell the pledged shares. Broker-dealers engaged by the selling stockholder may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling stockholder in amounts to be negotiated. If any broker-dealer acts as agent for the purchaser of shares, the broker-dealer may receive commission from the purchaser in amounts to be negotiated. The selling stockholder do not expect these commissions and discounts to exceed what is customary in the types of transactions involved. The selling stockholder and any broker-dealers or agents that are involved in selling the shares may be considered to be "underwriters" within the meaning of the Securities Act for such sales. An underwriter is a person who has purchased shares from an issuer with a view towards distributing the shares to the public. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be considered to be underwriting commissions or discounts under the Securities Act. We are required to pay all fees and expenses incident to the registration of the shares in this offering. However, we will not pay any commissions or any other fees in connection with the resale of the common stock in this offering. If we are notified by a selling stockholder that they have a material arrangement with a broker-dealer for the resale of the common stock, then we would be required to amend the registration statement of which this prospectus is a part, and file a prospectus supplement to describe the agreements between the selling stockholder and the broker-dealer. SELLING STOCKHOLDER Rineco Recycling, LLC presently owns 1,500,000 warrants to purchase our common stock at an exercise price of $0.01 per share. We issued the warrants to Rineco Recycling, LLC when they loaned us $1,500,000 in March 2003 pursuant to a promissory note that we gave to Rineco Recycling, LLC. Each warrant entitles Rineco Recycling, LLC to purchase one share of our common stock. The warrants are immediately exercisable and the warrants expire on April 30, 2005. Under the rules of the Commission, Rineco Recycling, LLC is deemed to be the beneficial owner of a similar number of shares of common stock, even though none of the warrants have been exercised as of April 25, 2003. The 1,500,000 shares of common stock being offered are issuable by us upon the exercise of the 44 warrants. Upon exercise of the warrants, Rineco Recycling, LLC will be able to resell the common stock through public secondary trading for all or a portion of the common stock from time to time. Rineco Recycling, LLC does not beneficially own any other shares of common stock. Rineco Recycling, LLC presently beneficially owns approximately 13% of our common stock. If Rineco Recycling, LLC sells all the shares of common stock in this offering, then Rineco will not own any shares of our common stock and Rineco Recycling, LLC will then own -0-% of our common stock. In January 2003 we signed a contract to process various waste streams for Rineco Chemical Industries, Inc., an entity related to Rineco Recycling, LLC. DESCRIPTION OF SECURITIES Our authorized capital stock consists of 50,000,000 shares of common stock, $0.001 par value, and 10,000,000 shares of preferred stock $0.001 par value. As of the date of this Prospectus, we have outstanding 10,112,144 shares of common stock, 2,733,686 shares of Series B Preferred Stock and 400,000 shares of Series D Preferred Stock. The following summary description of our common stock is qualified in its entirety by reference to our Articles of Incorporation ("Articles"), a copy of which is filed as an exhibit to the Registration Statement of which this Prospectus is a part. COMMON STOCK The holders of common stock are entitled to one vote per share with respect to all matters required by law to be submitted to our stockholders. The holders of common stock have the sole right to vote, except as otherwise provided by law or by the Articles, including provisions governing any Preferred Stock. The common stock does not have any cumulative voting, preemptive, subscription or conversion rights. Election of directors and other general stockholder action requires the affirmative vote of a majority of shares represented at a meeting in which a quorum is represented. The outstanding shares of common stock are, and the shares of common stock offered hereby will be, upon payment therefor as contemplated herein, validly issued, fully paid and non-assessable. Subject to the rights of any outstanding shares of Preferred Stock, the holders of common stock are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available therefor. However, our Series B Preferred Stock is entitled to receive dividends at such time, if any, that we declare dividends on our common stock, in an amount equal to the number of shares of common stock that the Series B Preferred Stock could be converted into at the time a dividend is declared, which could hinder our ability to pay dividends on our common stock. In the event of liquidation, dissolution or winding up of our affairs, the holders of common stock are entitled to share ratably in all assets remaining available for distribution to them after payment or provision for all liabilities and any preferential liquidation rights of any Preferred Stock then outstanding. 45 PREFERRED STOCK We are authorized to issue 10,000,000 shares of Preferred Stock, par value $0.001, of which there are outstanding, 2,733,686 shares of Series B Preferred Stock and 400,000 shares of Series D Preferred Stock. The Articles provide that the Board of Directors is authorized, without action by the holders of the common stock, to provide for the issuance of the authorized but unissued shares of Preferred Stock in one or more series, to establish the number of shares to be included in each series and to fix the designations, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. This includes, among other things, voting rights, conversion privileges, dividend rates, redemption rights, sinking fund provisions and liquidation rights which shall be superior to the common stock. The issuance of one or more series of the Preferred Stock could adversely affect the voting power of the holders of the common stock and could have the effect of discouraging or making more difficult any attempt by a person or a group to attain control of us. Our Series B Preferred Stock is entitled to receive dividends at such time, if any, that we declare dividends on our common stock, in an amount equal to the number of shares of common stock that the Series B Preferred Stock could be converted into at the time a dividend is declared. Our Series D Preferred Stock is entitled to receive cash dividends, of which $729,881 through March 31, 2003 (including accrued interest thereon) have been deferred by the holders until October 1, 2003. The holders of Series D Convertible Preferred Stock are entitled to receive out of funds legally available therefor, dividends in an annual amount equal to the prime rate plus one and one-half percent (1.5%) as reported by The Wall Street Journal on the outstanding stated value of the Series D Convertible Preferred Stock (which presently is $4,000,000.00). The dividends are calculated as of the last day of each quarter, and are payable quarterly in arrears (the "Dividend Payment"). Dividend Payments are due five (5) days after the close of each quarter. The initial quarterly dividend began accruing on October 1, 2000, for the quarter ending December 31,2000, and was not be due until five days after the close of the quarter ending December 31, 2000. The holders of Series D Convertible Preferred Stock were entitled to receive a one time special dividend of $75,777.78 ("Special Dividend") along with the quarterly payment due for the quarter ending March 31, 2001. The Special Dividend had interest calculated on the basis of actual days elapsed and a 360-day year, at the prime rate, as reported in the Wall Street Journal five (5) business days prior to the end of each calendar month or if not reported on such date then the closest business day thereto, plus one and five-tenths percent (1.5%). This special dividend has been deferred until October 1, 2003. 46 WARRANTS AND OPTIONS We presently have outstanding an aggregate of 7,801,442 options and warrants to purchase common stock. Approximately 3,012,780 of these warrants and options are in, at or within 5% of being in the money and are immediately exercisable. LEGAL MATTERS Certain legal matters relating to the issuance and resale of shares hereby will be passed upon for us by Axelrod, Smith & Kirshbaum, an Association of Professional Corporations, Houston, Texas. Robert D. Axelrod, Esq. owns 26,759 shares of our common stock. LEGAL PROCEEDINGS In July 2002, OnSite filed a lawsuit styled OnSite Technology LLC v. Duratherm, Inc., Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds; Civil Action No. H-02-2624; In the United States District Court for the Southern District of Texas against Duratherm, Inc. and Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds. OnSite's lawsuit alleges that Duratherm's remediation operations at its Galveston County, Texas facility infringed on OnSite's U.S. Patent No. 5,738,031 and requested a declaratory judgment that OnSite's operation of its remediation process does not infringe either of Heuer and Reynolds' U.S. Patent Nos. 4,990,237 and 5,269,906 over which Duratherm alleges control. OnSite is seeking a declaratory judgment that it does not infringe on either the Heuer and Reynolds patents. OnSite is also seeking damages for patent infringement, injunctive relief to prevent further patent infringement, and other relief that the court finds appropriate. The Defendants have filed an answer asserting that they do not infringe on OnSite's patent and that such patent is invalid. The Defendants' denial that there is any controversy between the parties regarding the Heuer and Reynolds patents, has been rejected by the court. This case is in the early stages of discovery. In July 2002, OnSite also initiated litigation styled OnSite Technology, LLC v. Duratherm, Inc. et al.; Cause No. 02CV0801; In the 56th Judicial District Court of Galveston County, Texas, against Duratherm, Inc., Duratherm Group, Inc., Barry Hogan and Jim Hogan. This lawsuit alleges that in November 1999, OnSite and Waste Control Specialists, L.L.C. ("WCS") entered into a contract wherein OnSite would, among other things, provide the necessary services, supplies and equipment to perform recycling and remediation services utilizing an indirect thermal desorption unit as specified therein. On information and belief, in late July or early August 2000, Defendants, acting in concert through Duratherm, Inc., sent or caused to be sent a letter(s) and/or other communication(s) to WCS, which OnSite alleges contained statements that were false and intended to deceive WCS, as to OnSite and OnSite's technology and indirect thermal desorption unit. OnSite alleges that as a result of such alleged false, deceptive and malicious statements, WCS terminated its contract with OnSite. In August 2000, Duratherm, Inc. filed suit against OnSite and WCS in the United States District Court for the Southern District of Texas under Civil Action No. H-00-2727, which suit was subsequently dismissed with prejudice by the United States District Judge. OnSite alleges that such suit was malicious and 47 contained false statements and allegations about OnSite and OnSite's technology and indirect thermal desorption unit. In February 2003 OnSite amended its petition to add John C. Hilliard as a defendant and to add as a claim against the defendants, the loss of a prospective contract with ExxonMobil. OnSite has also amended its petition to include as a defendant Duratherm's counsel, Conley Rose P.C., (for purposes of injunctive relief). The causes of action alleged by OnSite against the Defendants are (i) interference with contract; (ii) unfair competition and business disparagement; (iii) unjust enrichment; and (iv) injury to OnSite's business reputation. OnSite is seeking actual, consequential, incidental and compensatory damages, including, but not limited to, disgorgement, pre- and post-judgment interest, attorney's fees and costs and exemplary and punitive damages. OnSite is also seeking to enjoin these defendants and Duratherm's counsel, Conley Rose P.C., from interfering with the current and prospective business relationships of OnSite with regard to the thermal desorption units. The Defendants in this litigation, other than John C. Hilliard, have filed an answer denying the allegations contained in OnSite's petition. This case is in the early stages of discovery. EXPERTS Our Consolidated Balance Sheet as of December 31, 2002 and the related Consolidated Statements of Operations, Stockholders' Equity and Cash Flow for the year then ended have been audited by Ham, Langston & Brezina, L.L.P., independent auditors, as set forth in their report, incorporated by reference herein, in reliance upon such report and the authority of Ham, Langston & Brezina L.L.P. as experts in accounting and auditing. The consolidated financial statements as of December 31, 2001 and for the year ended December 31, 2001 included in this Registration Statement have been so included in reliance on the report (which contains an explanatory paragraph relating to the Company's ability to continue as a going concern as described in Note 2 to the consolidated financial statements) of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. CHANGES IN OUR CERTIFYING ACCOUNTANT There have been no disagreements with our independent accountants regarding accounting and financial disclosure matters. On April 2, 2002, we dismissed PricewaterhouseCoopers, LLP as our independent accountants. Our audit committee and board of directors participated in and approved the decision to change independent accountants. The reports of PricewaterhouseCoopers LLP on the financial statements for 2001 contained no adverse opinion or disclaimer of opinion and were not qualified as to audit scope or accounting principle, however such reports for each of the years were modified to express substantial doubt with respect to our ability to continue as a going concern. In connection with the audit for 2001 and through April 2, 2002, there were no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP would have caused them to make reference thereto in their report on the financial statements for such years. 48 During 2001 and through April 2, 2002, there were no reportable events (as defined in Regulation S-K Item 304. PricewaterhouseCoopers LLP has furnished a letter addressed to the SEC stating it agrees with the above statements. We engaged Ham, Langston & Brezina, LLP as our new independent accountants as of April 3, 2002. During 2000 and 2001 and through April 3, 2002, we had not consulted with Ham, Langston & Brezina, LLP regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on our financial statements, and neither a written report was provided to us or oral advice was provided that Ham, Langston & Brezina, LLP concluded was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement, as that term is defined in Item 304 of Regulation S-B and the related instructions to Item 304 of Regulation S-B, or a reportable event, as that term is defined in Item 304 of Regulation S-B. 49 CONSOLIDATED FINANCIAL STATEMENTS ENVIRONMENTAL SAFEGUARDS, INC. __________ CONSOLIDATED FINANCIAL STATEMENTS WITH REPORT OF INDEPENDENT ACCOUNTANTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 ENVIRONMENTAL SAFEGUARDS, INC. TABLE OF CONTENTS __________ PAGE ---- Reports of Independent Accountants F-2 Audited Financial Statements Consolidated Balance Sheet as of December 31, 2002 F-4 Consolidated Statement of Operations for the years ended December 31, 2002 and 2001 F-5 Consolidated Statement of Stockholders' Equity for the years ended December 31, 2002 and 2001 F-6 Consolidated Statement of Cash Flows for the years ended December 31, 2002 and 2001 F-7 Notes to Consolidated Financial Statements F-8 F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders Environmental Safeguards, Inc. We have audited the accompanying consolidated balance sheet of Environmental Safeguards, Inc. as of December 31, 2002 and the related consolidated statements of operations, stockholders' deficit and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Environmental Safeguards, Inc. as of December 31, 2002, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Ham, Langston & Brezina, L.L.P. Houston, Texas March 20, 2003 F-2 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders Environmental Safeguards, Inc. In our opinion, the accompanying consolidated statement of operations, stockholders' equity and cash flows present fairly, in all material respects, the consolidated results of operations and cash flows of Environmental Safeguards, Inc. for the year ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2001, the Company has incurred losses from operations and has not generated sufficient business backlog. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ PricewaterhouseCoopers LLP Houston, Texas February 28, 2002 F-3
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED BALANCE SHEET DECEMBER 31, 2002 __________ (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ASSETS ------ Current assets: Cash and cash equivalents $ 97 Accounts receivable 97 Prepaid expenses 173 --------- Total current assets 367 Property and equipment, net 5,506 Acquired engineering design and technology, net of accumulated amortization of $1,756 1,203 Other assets 3 --------- Total assets $ 7,079 ========= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Notes payable to related parties $ 250 Accounts payable 31 Dividends payable 617 Accrued interest 63 Other accrued liabilities 592 --------- Total current liabilities 1,553 --------- Minority interest 1,943 Commitments and contingencies Stockholders' equity: Preferred stock; Series B convertible; voting, $.001 par value (aggregate liquidation value - $2,898) 5,000,000 shares authorized; 2,733,686 shares issued and outstanding 3 Preferred stock; Series D convertible, non-voting, cumulative $.001 par value (aggregate liquidation value $4,000); 400,000 shares authorized, issued and outstanding 1 Common stock; $.001 par value; 50,000,000 shares authorized; 10,112,144 shares issued and outstanding 10 Additional paid-in capital 14,981 Accumulated deficit (11,412) --------- Total stockholders' equity 3,583 --------- Total liabilities and stockholders' equity $7,079 =========
The accompanying notes are an integral part of these consolidated financial statements. F-4
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED STATEMENT OF OPERATIONS __________ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31, ------------------ 2002 2001 -------- -------- Revenue $ 943 $ 2,987 Cost of revenue 1,968 3,546 -------- -------- Gross margin (1,025) (559) Selling, general and administrative expenses 1,713 2,645 Amortization of acquired engineering design and technology 408 408 Research and development 30 71 -------- -------- Loss from operations (3,176) (3,683) Other income (expenses): Gain on sale of equipment - 6,252 Interest income 2 32 Interest expense (43) (839) Other (2) 40 -------- -------- Income (loss) before benefit (provision) for income taxes and minority interest (3,219) 1,802 Benefit (provision) for income taxes 79 (536) -------- -------- Income (loss) before minority interest (3,140) 1,266 Minority interest 97 241 -------- -------- Net income (loss) $(3,043) $ 1,507 ======== ======== Net income (loss) applicable to common stockholders $(3,296) $ 1,169 ======== ======== Net income (loss) per share-basic $ (0.33) $ 0.12 ======== ======== Net income (loss) per share-diluted $ (0.33) $ 0.05 ======== ======== Weighted average shares outstanding-basic 10,112 10,112 ======== ======== Weighted average shares outstanding-diluted 10,112 23,142 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-5
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY __________ (IN THOUSANDS, EXCEPT SHARE AMOUNTS) TOTAL SERIES B SERIES C SERIES D ADDITIONAL STOCK- PREFERRED PREFERRED PREFERRED COMMON PAID-IN ACCUMULATED HOLDERS' STOCK STOCK STOCK STOCK CAPITAL DEFICIT EQUITY ---------- ---------- ---------- ------- ----------- ------------- ---------- Balance as of December 31, 2000 3 - 1 10 14,935 (9,285) 5,664 Issuance of 188,571 warrants to pur- chase common stock in connection with senior secured debt (Note 4) - - - - 46 - 46 Dividends on Series D Preferred stock - - - - - (338) (338) Net income - - - - - 1,507 1,507 ---------- ---------- ---------- ------- ----------- ------------- ---------- Balance as of December 31, 2001 3 - 1 10 14,981 (8,116) 6,879 Dividends on Series D Preferred stock - - - - - (253) (253) Net loss - - - - - (3,043) (3,043) ---------- ---------- ---------- ------- ----------- ------------- ---------- Balance as of December 31, 2002 $ 3 $ - $ 1 $ 10 $ 14,981 $ (11,412) $ 3,583 ========== ========== ========== ======= =========== ============= ========== The accompanying notes are an integral part of these consolidated financial statements.
F-6
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS __________ (IN THOUSANDS) YEAR ENDED DECEMBER 31, ------------------ 2002 2001 -------- -------- Cash flows from operating activities: Net income (loss) $(3,043) $ 1,507 Adjustment to reconcile net loss to net cash used by operating activities: Minority interest (97) (241) Deferred tax expense - 30 Depreciation expense 1,218 2,080 Amortization of acquired engineering design and technology 408 408 Amortization of discount - 344 Gain on sale of equipment - (6,252) Changes in operating assets and liabilities: Accounts receivable 1,212 (286) Prepaid expenses and other assets (37) (55) Accounts payable (115) (10) Accrued liabilities (58) (195) Income taxes payable (254) 34 -------- -------- Net cash used by operating activities (766) (2,636) -------- -------- Cash flows from investing activities: Proceeds from sale of equipment - 6,900 Purchases of equipment (185) (260) -------- -------- Net cash provided (used) by investing activities (185) 6,640 -------- -------- Cash flows from financing activities: Proceeds from notes payable to stockholders 250 - Payments on long-term debt - (5,406) Dividends paid on Series C and Series D preferred stock - (199) Distribution to minority interest - (669) -------- -------- Net cash provided (used) by financing activities 250 (6,274) -------- -------- Net decrease in cash and cash equivalents (701) (2,270) Cash and cash equivalents, beginning of year 798 3,068 -------- -------- Cash and cash equivalents, end of year $ 97 $ 798 ======== ======== Supplemental disclosure of cash flow information: Cash paid for interest $ - $ 695 ======== ======== Cash paid for income taxes $ - $ 472 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-7 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS __________ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ---------------------------------------------------- Environmental Safeguards, Inc. (the "Company") provides environmental remediation and hydrocarbon reclamation/recycling services principally to oil and gas companies, using proprietary Indirect Thermal Desorption ("ITD") technology. To date the primary service offered by the Company has been the remediation of soil contaminated by oil-based drill cuttings and the subsequent recovery of diesel and synthetic oils. PRINCIPLES OF CONSOLIDATION ----------------------------- The consolidated financial statements include the accounts of the Company and its majority owned or controlled subsidiaries after elimination of all significant intercompany accounts and transactions. MANAGEMENT ESTIMATES --------------------- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. These estimates mainly involve the useful lives of property and equipment, the valuation of deferred tax assets and the realizability of accounts receivable. RESEARCH AND DEVELOPMENT -------------------------- Research and development activities are expensed as incurred, including costs relating to patents or rights which may result from such expenditures. REVENUE RECOGNITION -------------------- Revenue is recognized at the time services are performed, or in the event of the sale of an ITD unit, when the equipment is shipped. CONCENTRATIONS OF CREDIT RISK -------------------------------- Financial instruments which subject the Company to concentrations of credit risk include cash and cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents with major financial institutions selected based upon management's assessment of the banks' financial stability. Balances periodically exceed the $100,000 federal depository insurance limit. The Company has not experienced any losses on deposits. Accounts receivable generally arise from sales of services to customers operating in the United States and Latin America. Collateral is generally not required for credit granted. As of December 31, 2002 all of the Company's trade receivables were due from two customers for services performed in the United States and Mexico. The Company has in place insurance to cover certain exposure in its foreign operations and provides allowances for potential credit losses when necessary. F-8 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED ---------------------------------------------------------------- CASH EQUIVALENTS ----------------- The Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents. PROPERTY AND EQUIPMENT ------------------------ Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of 8 years for ITD Units and 3 to 5 years for office furniture and equipment and transportation and other equipment. Effective October 1, 2002, the Company changed the estimated useful lives of ITD units from 5 to 8 years to more accurately reflect the Company's experience with useful lives of ITD unites (See Note 3). Additions or improvements that increase the value or extend the life of an asset are capitalized. Expenditures for normal maintenance and repairs are expensed as incurred. Disposals are removed from the accounts at cost less accumulated depreciation and any gain or loss from disposition is reflected in operations currently in other income/expenses in the statement of operations. INCOME TAXES ------------- The Company uses the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and income tax carrying amounts of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance, if necessary, is provided against deferred tax assets, based upon management's assessment as to their realization. STOCK-BASED COMPENSATION ------------------------- Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") established financial accounting and reporting standards for stock-based employee compensation plans. It defined a fair value based method of accounting for an employee stock option or similar equity instrument and encouraged all entities to adopt that method of accounting for all of their employee stock compensation plans and include the cost in the income statement as compensation expense. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". The Company accounts for compensation cost for stock option plans in accordance with APB Opinion No. 25. ACQUIRED ENGINEERING DESIGN AND TECHNOLOGY ---------------------------------------------- Acquired engineering design and technology represents the intangible value associated with certain proprietary equipment and process designs acquired by the Company in the acquisition of OnSite Technology, L.L.C. ("OnSite") in 1997. In the acquisition of OnSite, the purchase price was allocated to the assets acquired and liabilities assumed based on independent appraisal. This intangible asset is being amortized over an estimated useful life of 8 years using the straight-line method. F-9 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED ---------------------------------------------------------------- IMPAIRMENT OF LONG-LIVED ASSETS ---------------------------------- In the event facts and circumstances indicate the carrying value of a long-lived asset, including associated intangibles, may be impaired, an evaluation of recoverability is performed by comparing the estimated future undiscounted cash flows associated with the asset to the asset's carrying amount to determine if a write-down to market value or discounted cash flow is required. Given the homogeneous nature and geographic deployment flexibility of such assets, and based upon a recent evaluation by management, an impairment write-down of the Company's long-lived assets was not deemed necessary. Management has evaluated the carrying value of long-lived assets, including associated intangibles. An evaluation of recoverability is performed by comparing the estimated future undiscounted cash flows associated with the asset to the asset's carrying amount to determine if a write-down to market value or discounted cash flow is required. Given the homogeneous nature and geographic deployment flexibility of such assets, and based upon this evaluation by management, impairment of the Company's long-lived assets has not been deemed necessary. TRANSLATION OF FOREIGN CURRENCIES ------------------------------------ The financial statements of foreign subsidiaries are measured as if the functional currency were the U.S. dollar. The remeasurement of local currencies into U.S. dollars creates translation adjustments which are included in net income. FAIR VALUE OF FINANCIAL INSTRUMENTS --------------------------------------- The Company includes fair value information in the notes to financial statements when the fair value of its financial instruments is different from the book value. When the book value approximates fair value, no additional disclosure is made. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS -------------------------------------------- In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," which requires all business combinations initiated after June 30, 2001 be accounted for using the purchase method. In addition, SFAS No. 141 further clarifies the criteria to recognize intangible assets separately from goodwill. Specifically, SFAS No. 141 requires that an intangible asset may be separately recognized only if such an asset meets the contractual-legal criterion or the separability criterion. The implementation of SFAS No. 141 did not have a material impact on the Company's results of operations or financial position. F-10 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED ----------------------------------------------------------- RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS, CONTINUED -------------------------------------------------------- In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," under which goodwill and intangible assets with indefinite useful lives are no longer amortized but will be reviewed for impairment annually, or more frequently if certain events or changes in circumstances indicate that the carrying value may not be recoverable. The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss. The impairment test for intangible assets with indefinite useful lives consists of a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. Intangible assets with finite useful lives will continue to be amortized over their useful lives and will be reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The implementation of SFAS No. 142 at did not have a material impact on the Company's results of operations or financial position. In August 2001, the FASB issued SFAS No. 144, which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and certain provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 retains the fundamental provisions of SFAS No. 121 related to: (i) the recognition and measurement of the impairment of long-lived assets to be held and used, and (ii) the measurement of long-lived assets to be disposed by sale. It provides more guidance on estimating cash flows when performing recoverability tests, requires long-lived assets to be disposed of other than by sale to be classified as held and used until disposal, and establishes more restrictive criteria to classify long-lived assets as held for sale. In addition, SFAS No. 144 supersedes the accounting and reporting provisions of APB Opinion No. 30 for the disposal of a segment of a business. However, it retains the basic provisions of APB Opinion No. 30 to report discontinued operations separately from continuing operations and extends the reporting of a discontinued operation to a component of an entity. The implementation of SFAS No. 144 did not have a material impact on the Company's results of operations or financial position. F-11 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED ----------------------------------------------------------- RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS, CONTINUED -------------------------------------------------------- In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. In addition, SFAS No. 146 establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002, but early adoption is permitted. The Company is currently evaluating the adoption date; however the impact of its adoption is not expected to have a significant impact on the Company's financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based Compensation", which amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No. 28, "Interim Financial Reporting", to require disclosure of those effects in interim financial statements. SFAS No. 148 is effective for fiscal years ended after December 15, 2002, but early adoption is permitted. The Company will adopt SFAS No. 148 on January 1, 2003; however, the Company does not expect that adoption will have a significant impact on its financial reporting. 2. LIQUIDITY ISSUES ----------------- During the year ended December 31, 2002 and 2001, the Company faced significant liquidity issues that caused the Company's prior independent accountants to include an explanatory paragraph in their auditor's report on the Company's consolidated financial statements, as of December 31, 2001 and for the two years in the period then ended, describing the uncertainty about the Company's ability to continue as a going concern. Below is an analysis of the circumstances that led to a going concern explanatory paragraph in the Company's 2001 financial statements, followed by a description of changes in circumstances that resulted in the current auditors issuing an unqualified opinion, without a going concern explanatory paragraph, on the Company's 2002 financial statements. BACKGROUND AND 2001 CIRCUMSTANCES ------------------------------------ Since its inception, the Company has expended a significant portion of its resources to develop markets and industry awareness of the capabilities of its indirect thermal desorption recycling process. The Company's efforts have been focused on the development, production and sale of environmental recycling technologies and services to oil and gas industry participants, waste management companies and other industrial customers. The Company's efforts to develop markets and produce equipment have required significant amounts of capital including long-term debt secured by the Company's ITD units and related ITD F-12 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 2. LIQUIDITY ISSUES, CONTINUED ----------------------------- BACKGROUND AND 2001 CIRCUMSTANCES, CONTINUED ------------------------------------------------ technology. With the exception of the profitability impact from the Company's sale of three ITD units and certain licensing rights in late 2001 (as noted below and in Note 3), the Company has incurred recurring net losses and has been dependent on revenue from a limited customer base to provide cash flows. These factors were the basis for the Company's predecessor auditor's conclusion that at December 31, 2001, substantial doubt existed about the Company's ability to continue as a going concern. The Company is continually seeking to obtain service contracts in the markets that it serves. In December 2001, the Company completed the sale of three of its ITD units and certain licensing rights, and the proceeds were used to pay off all the Company's senior debt. At December 31, 2001, the Company's predecessor auditor believed that the Company's long-term viability as a going concern was dependent on the repositioning of its asset base and the achievement of a sustaining level of profitability. To the extent the Company's cash reserves and future cash flows from operations were insufficient to meet future cash requirements, the Company would need to raise funds through the infusion of equity, the issuance of debt securities or the sale of ITD units. Doubt existed as to whether such financing would be available on terms acceptable to the Company or at all. Further, the sale of additional equity or convertible debt securities may result in dilution to the Company's stockholders. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. NEW DEVELOPMENTS SUBSEQUENT TO DECEMBER 31, 2002 ------------------------------------------------------ In January and March 2003, the Company entered into two important agreements that management believes will provide cash resources sufficient to cover the Company's 2003 cash requirements. The first agreement is a processing contract with a major waste management and disposal contractor for services at a facility in Arkansas. The second agreement is a $1,500,000 long-term financing arrangement collateralized by certain of the Company's ITD units. (See Note 14) OTHER ----- Management has evaluated the carrying value of long-lived assets, including associated intangibles. An evaluation of recoverability is performed by comparing the estimated future undiscounted cash flows associated with the assets to their carrying amount to determine if a write-down to market value or discounted cash flow is required. Given the homogeneous nature and geographic deployment flexibility of such assets, and based upon this evaluation by management, impairment of the Company's long-lived assets has not been deemed necessary. F-13 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 3. PROPERTY AND EQUIPMENT ------------------------ Property and equipment consists of the following at December 31, 2002 (in thousands): ITD Remediation/Recycling Units and auxiliary equipment $11,962 Office furniture and equipment 36 Transportation and other equipment 49 ------- 12,047 Less accumulated depreciation 6,541 ------- Property and equipment, net $ 5,506 ======= On October 1, 2002, the Company changed the depreciable lives of its ITD units from five to eight years. This change in estimate was made to more accurately reflect the Company's experience concerning the useful life of its equipment and to conform with industry practices for similar equipment. The change in estimate, which is being applied on a prospective basis, resulted in a decrease in depreciation expense and net loss of $215,000 for the year ended December 31, 2002. The change reduced basic and diluted loss per share by $0.02 and, accordingly, if the change in estimate had not been adopted by the Company, basic and diluted net loss per share for the year ended December 31, 2002 would have been $0.35 per share. On August 23, 2001, the Company entered into a contract to sell three of its used ITD units to a customer in Mexico. The total sales price for the ITD units was $6,900,000 and the Company recognized a gain on the sale of $6,252,000, which is presented in other income in the accompanying statement of operations. In connection with the sale, the Company granted its customer in Mexico an exclusive license for, and right to use, ITD technology in Mexico (subject to an existing agreement) and an option to acquire a fourth ITD unit from the Company. 4. NOTES PAYABLE TO RELATED PARTIES ------------------------------------ In July 2002, the Company obtained uncollateralized loans totaling $250,000 from Cahill Warnock Strategic Partners, L.P. and Strategic Associates, L.P. These loans bear interest of 12% per year and were originally due in January 2003 but have been extended to September 2003. David Warnock, a director of the Company, is a general partner of Cahill Warnock Strategic Partners, L.P. and a managing member of the general partner of Strategic Associates, L.P. F-14 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 5. OTHER ACCRUED LIABILITIES --------------------------- Other accrued liabilities consists of the following at December 31, 2002 (in thousands): Accrued property and franchise taxes $ 15 Accrued professional fees 40 Accrued joint-company expenses 332 Accrued capital improvements 80 Accrued executive salaries 116 Accrued operating costs 9 ---- $592 ==== 6. LEASE COMMITMENTS ------------------ The Company leases office space and a storage and maintenance area for its equipment under operating leases. The leases have a remaining term of less than one year. Management intends to replace these leases in the normal course of business. Rental expense under operating leases was $52,000 and $100,000 during the years ended December 31, 2002 and 2001, respectively. 7. INCOME TAXES ------------- Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities at December 31, 2002 were as follows (in thousands): Deferred tax liabilities: Basis of property and equipment $ 150 -------- Total deferred tax liabilities 150 -------- Deferred tax assets: Net operating loss carryforwards 2,040 All other, net 340 -------- Total deferred tax assets 2,380 -------- Valuation allowance (2,230) -------- 150 -------- Net deferred tax assets $ - ======== F-15 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 7. INCOME TAXES, CONTINUED ------------------------- For financial reporting purposes, income before provision for income taxes and minority interest includes the following components (in thousands): 2002 2001 -------- -------- United States $(2,931) $ 4,839 Foreign (288) (3,037) -------- -------- Income (loss) before provision for income taxes and minority interest $(3,219) $ 1,802 ======== ======== Significant components of the benefit (provision) for income taxes are as follows (in thousands): 2002 2001 ----- ------ Current: Federal $ 79 $(247) Foreign - (259) ----- ------ Total current 79 (506) ----- ------ Deferred: Federal - - Foreign - (30) ----- ------ Total deferred - (30) ----- ------ Benefit (provision) for income taxes $ 79 $(536) ===== ====== The differences between the statutory income tax rate and the Company's effective income tax rate are as follows: 2002 2001 ----- ----- Federal statutory rate 34% (34%) State income taxes - (9%) Foreign income taxes - (10%) Foreign tax credits and other (16%) (38%) Change in valuation allowance (18%) 61% ----- ----- Benefit (provision) for income taxes 2% (30%) ===== ===== F-16 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 7. INCOME TAXES, CONTINUED ------------------------- As of December 31, 2002, for U.S. federal income tax reporting purposes, the Company has approximately $6,000,000 of unused net operating losses ("NOLs") available for carryforward to future years. The benefit from carryforward of such NOLs will expire during the years ended December 31, 2003 to 2022. Because United States tax laws limit the time during which NOL carryforwards may be applied against future taxable income, the Company may be unable to take full advantage of its NOL for federal income tax purposes should the Company generate taxable income. Based on such limitation, the Company has significant NOL carryforwards for which realization of tax benefits is uncertain. Further, the benefit from utilization of NOL carryforwards could be subject to limitations if material ownership changes occur in the Company. Based on such limitations, the Company has significant NOL's for which realization of tax benefits is uncertain. 8. STOCKHOLDERS' EQUITY --------------------- The Company's articles of incorporation authorize the issuance of up to 10,000,000 shares of preferred stock with characteristics determined by the Company's board of directors. Effective December 17, 1997, the board of directors authorized the issuance and sale of up to 5,000,000 shares of Series B convertible preferred stock and up to 400,000 shares of Series C non-voting non-convertible preferred stock. During the year ended December 31, 2000, the board of directors authorized the issuance of up to 400,000 shares of Series D convertible preferred stock. SERIES B CONVERTIBLE PREFERRED STOCK ---------------------------------------- In 1997, the Company issued 3,771,422 shares of $0.001 par value Series B convertible preferred stock for $4,000,000, or $1.06 per share. Dividends are paid at the same rate as common stock based upon the conversion rate. The Series B convertible preferred stock can be converted to common stock at any time at the option of the holder. The initial rate is 1 common share for each preferred share; however, the conversion rate is subject to adjustments to prevent dilution. The holders of the Series B convertible preferred stock have essentially the same voting rights as the holders of common stock. The Series B convertible preferred stock has a liquidation preference of $1.06 per share plus any unpaid dividends. SERIES C PREFERRED STOCK --------------------------- In 1997, the Company issued 400,000 shares of Series C non-voting preferred stock with a $0.001 per share par value and a $10 per share stated value. The Series C preferred stock carried a quarterly dividend payable in arrears of prime plus 1.5% based on the stated value of the stock. The Series C preferred stock was redeemable at the option of the Company at a price of $10 per share plus any unpaid dividends. Proceeds of $4,000,000 from the Series C preferred stock were recorded net of a discount of $809,000, which included related offering costs incurred and the allocation of a portion of the proceeds to the warrants issued to the same investors. The Series C preferred stock was accreted to its liquidation value over a period of 26 months to February 17, 2000. The accretion of the Series C preferred stock was deducted from the net loss to derive the net loss applicable to common stockholders in the calculation of earnings per share (See Note 9). As described below, during 2000, Series C preferred stock was exchanged for Series D convertible preferred stock. F-17 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 8. STOCKHOLDERS' EQUITY, CONTINUED --------------------------------- SERIES D PREFERRED STOCK --------------------------- During 2000, the Company exchanged 400,000 newly issued shares of Series D convertible Preferred Stock for Series C non-convertible Preferred Stock held by the Company's primary lender. The newly issued shares of Series D Preferred stock are convertible into common stock at a conversion price of $2.25 per share until December 31, 2002, and a conversion price of $1.00 after December 31, 2002. In the event of a default under the loan agreement, the conversion price was originally the lesser of $1.00 per share or the averaging thirty-day trailing price; however, in March 2001, the conversion price was fixed at $0.37. The conversion feature associated with the 400,000 shares of Series D Preferred Stock was valued at $168,000 based on an independent appraisal. The value of the conversion feature, representing unaccreted discount, was amortized to expense over the remaining term of the debt using the effective interest method. Other than the conversion feature of the Series D Preferred Stock, its features and preferences are the same as the Series C Preferred Stock. STOCK OPTION PLAN ------------------- The Company has adopted the 1998 Stock Option Plan (the "Option Plan") under which incentive stock options for up to 800,000 shares of the Company's common stock may be awarded to officers, directors and key employees. The Option Plan is designed to attract and reward key executive personnel. At December 31, 2002, 547,500 of the 800,000 shares of common stock reserved for the issuance under the Option Plan have been granted and remain outstanding. Stock options granted pursuant to the Option Plan expire not more than ten years from the date of grant and typically vest over two years, with 50% vesting after one year and 50% vesting in the succeeding year. All of the options granted by the Company were granted at an option price equal to the fair market value of the common stock at the date of grant. STOCK OPTIONS -------------- The Company periodically issues incentive stock options to key employees, officers, and directors to provide additional incentives to promote the success of the Company's business and to enhance the ability to attract and retain the services of qualified persons. The issuance of such options are approved by the Board of Directors. The exercise price of an option granted is determined by the fair market value of the stock on the date of grant. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation", requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options is greater than or equals the market price of the underlying stock on the date of grant, no compensation expense has been recognized. F-18 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 8. STOCKHOLDERS' EQUITY, CONTINUED --------------------------------- STOCK OPTIONS, CONTINUED -------------------------- Proforma information regarding net income and earnings per share is required by Statement 123, is determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model. No options were granted in 2002 or 2001 and, accordingly, no option pricing assumptions or proforma information is presented. The Black-Scholes option valuation model was developed for use in estimating fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. There were no stock options granted, exercised, expired or forfeited during the years ended December 31, 2002 or 2001. The weighted average exercise price of options outstanding at December 31, 2002 and 2001 was $1.38 per share. All outstanding stock options are exercisable at December 31, 2002 and 2001. A summary of outstanding stock options at December 31, 2002, follows: REMAINING NUMBER OF COMMON CONTRACTUAL STOCK EQUIVALENTS EXPIRATION DATE LIFE (YEARS) EXERCISE PRICE ----------------- --------------- ------------ --------------- 2,470,300 November 2005 2.9 $ 0.60 112,500 March 2007 4.2 1.44 480,000 March 2007 4.2 2.50 35,000 November 2007 4.9 1.44 356,813 December 2007 5.0 1.44 613,831 December 2007 5.0 3.00 1,053 January 2008 5.1 2.38 800 January 2008 5.1 3.12 770 January 2008 5.1 3.25 625 January 2008 5.1 4.00 47,053 April 2008 5.7 5.00 122,417 April 2008 5.7 1.44 547,500 December 2008 6.0 1.69 ----------------- 4,788,662 ================= F-19 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 8. STOCKHOLDERS' EQUITY, CONTINUED --------------------------------- STOCK WARRANTS --------------- Following is a summary of stock warrant activity: NUMBER OF EXERCISE WEIGHTED SHARES PRICE AVERAGE PRICE --------- --------- -------------- Warrants outstanding as of December 31, 2000 1,124,209 $ 0.01 $ 0.01 Issued 188,571 $ 0.01 $ 0.01 Canceled - - - Exercised - - - --------- Warrants outstanding as of December 31, 2001 1,312,780 $ 0.01 $ 0.01 Issued - - - Canceled - - - Exercised - - - --------- Warrants outstanding as of December 31, 2002 1,312,780 $ 0.01 $ 0.01 ========= All warrants outstanding were issued in connection with the funding of certain notes payable that were repaid in 2001. All warrants bear an exercise price of $0.01 per share, are currently exercisable, and expire in December 2007. 9. EARNINGS PER SHARE -------------------- Basic earnings per common share are based on the weighted average number of common shares outstanding in each year and after preferred stock dividend requirements. Diluted earnings per common share assume that any dilutive convertible debentures and convertible preferred shares outstanding at the beginning of each year were converted at those dates, with related interest, preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which market price exceeds exercise price, less shares which could have been purchased by the Company with related proceeds. The convertible preferred stock and outstanding stock options and warrants were not included in the computation of diluted earnings per common share for 2002 since their effect was antidilutive. F-20 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 9. EARNINGS PER SHARE, CONTINUED -------------------------------- The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share information): 2002 2001 -------- -------- Numerator: Net income (loss) $(3,043) $ 1,507 Less: Series C and D Preferred stock dividends ($0.63 and $0.85 per share in 2002 and 2001, respectively) (253) (338) -------- -------- Net income (loss) applicable to common stockholders-numerator for basic and diluted earnings per share $(3,296) $ 1,169 ======== ======== Denominator: Denominator for basic earnings per share- weighted average shares 10,112 10,112 Effect of dilutive securities: Warrants - 1,069 Convertible Series B preferred stock - 2,734 Convertible Series D preferred stock - 9,227 -------- -------- Dilutive potential common shares - 13,030 -------- -------- Denominator for diluted earnings per share- adjusted weighted average shares and assumed conversions 10,112 23,142 ======== ======== Basic earnings per share $ (0.33) $ 0.12 ======== ======== Diluted earnings per share $ (0.33) $ 0.05 ======== ======== The following table sets forth the computation of basic and diluted earnings per share (in thousands): 2002 2001 -------- ------- Numerator: Net income (loss) $(3,043) $1,507 Less: Series C and D Preferred stock dividends ($0.63 and $0.85 per share) in 2002 and 2001, respectively (253) (338) -------- ------- Net income (loss) applicable to common stockholders-numerator for basic and diluted earnings per share $(3,296) $1,169 ======== ======= F-21 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 10. 401(K) SALARY DEFERRAL PLAN ------------------------------ The Company has a 401(k) salary deferral plan (the "Plan") which became effective on January 1, 1998, for eligible employees who have met certain service requirements. The Plan does not provide for Company matching or discretionary contributions and, accordingly, the Company recognized no expense under the Plan in 2002 or 2001. 11. LITIGATION ---------- In July 2002, OnSite filed a lawsuit styled OnSite Technology LLC v. Duratherm, Inc., Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds; Civil Action No. H-02-2624; In the United States District Court for the Southern District of Texas against Duratherm, Inc. and Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds. OnSite's lawsuit alleges that Duratherm's remediation operations at its Galveston County, Texas facility infringed on OnSite's U.S. Patent No. 5,738,031 and requested a declaratory judgment that OnSite's operation of its remediation process does not infringe either of Heuer and Reynolds' U.S. Patent Nos. 4,990,237 and 5,269,906 over which Duratherm alleges control. The Defendants have filed an answer asserting that they do not infringe on OnSite's patent and that such patent is invalid. The defendants' denial that any controversy exists between the parties regarding the Heuer and Reynolds' patents has been rejected by the court. This case is in the early stages of discovery. In July 2002, OnSite also initiated litigation styled OnSite Technology, LLC v. Duratherm, Inc. et al.; Cause No. 02CV0801; In the 56th Judicial District Court of Galveston County, Texas, against Duratherm, Inc., Duratherm Group, Inc., Barry Hogan and Jim Hogan. This lawsuit alleges that in November 1999, OnSite and Waste Control Specialists, L.L.C. ("WCS") entered into a contract wherein OnSite would, among other things, provide the necessary services, supplies and equipment to perform recycling and remediation services utilizing an indirect thermal desorption unit as specified therein. On information and belief, in late July or early August 2000, Defendants, acting in concert through Duratherm, Inc., sent or caused to be sent a letter(s) and/or other communication(s) to WCS, which OnSite alleges contained statements that were false and intended to deceive WCS, as to OnSite and OnSite's technology and indirect thermal desorption unit. As a result of such false, deceptive and malicious statements, WCS terminated its contract with OnSite.In August 2000, Duratherm, Inc. filed suit against OnSite and WCS in the United States District Court for the Southern District of Texas under Civil Action No. H-00-2727, which suit was subsequently dismissed with prejudice by the United States District Judge. OnSite alleges that such suit was malicious and contained false statements and allegations about OnSite and OnSite's technology and indirect thermal desorption unit. In February 2003 OnSite amended its petition to add John C. Hilliard as a defendant and to add as a claim against the defendants, the loss of a prospective contract with ExxonMobil. OnSite has also amended its petition to include as a defendant Duratherm's counsel, Conley Rose P.C., (for purposes of injunctive relief). The causes of action alleged by OnSite against the Defendants are (i) interference with contract; (ii) unfair competition and business disparagement; (iii) unjust enrichment; and (iv) injury to OnSite's business reputation. OnSite is seeking actual, consequential, incidental and compensatory damages, including, but not limited to, disgorgement, pre- and post-judgment interest, attorney's fees and costs and exemplary and punitive damages. OnSite is also seeking to enjoin these defendants and Duratherm's counsel, Conley Rose P.C., from interfering with the current and prospective business relationships of OnSite with regard to the thermal desorption units. The Defendants in this litigation, other than John C. Hilliard, F-22 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 11. LITIGATION, CONTINUED ---------------------- have filed an answer denying the allegations contained in OnSite's petition. The answers from John C. Hilliard and Conley Rose P.C. are not yet due as of March 26, 2003. This case is in the early stages of discovery. The Company is from time to time involved in other litigation incidental to its business, which at times involves claims for significant monetary amounts, some of which would not be covered by insurance. Presently the Company has no existing litigation. 12. RELATED PARTY TRANSACTIONS ---------------------------- In July 2002, the Company obtained uncollateralized loans totaling $250,000 from certain stockholders (See Note 4). In March 2001 and September 2000, the Company entered into agreements with its primary lenders and holders of its outstanding preferred stock to defer various principal and interest payments on its senior debt. The senior debt was fully repaid in December 2001. 13. SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMERS INFORMATION -------------------------------------------------------- The Company currently operates in the environmental remediation and hydrocarbon reclamation/recycling services. Substantially all revenues result from the sale of services using the Company's ITD units. The Company's reportable segments are based upon geographic area and all intercompany revenue and expenses are eliminated in computing revenues and operating income (loss). All foreign subsidiaries of the Company operate with the U.S. dollar as their functional currency and, accordingly, no cumulative translation adjustment is presented in the accompanying balance sheet. The Company and OnSite share office facilities and certain employees. Shared costs are generally specifically identified by company; however, certain costs must be allocated based upon management's estimates. The corporate component of operating income (loss) represents corporate general and administrative expenses. Corporate assets include cash and cash equivalents, and restricted cash investments. Following is a summary of segment information: 2002 2001 ------ ------ Revenue (in thousands): United States $ 49 $ 140 Latin America 894 2,847 ------ ------ Total revenue $ 943 $2,987 ====== ====== F-23 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 13. SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION, CONTINUED ------------------------------------------------------------- 2002 2001 -------- -------- Depreciation and Amortization (in thousands): United States $ 1,624 $ 1,810 United Kingdom - 259 Latin America - 419 -------- -------- Total depreciation and amortization $ 1,624 $ 2,488 ======== ======== Income (Loss) From Operations (in thousands): United States $(2,887) $(2,930) United Kingdom - (559) Latin America (94) 93 Middle East (194) (286) Corporate (1) (1) -------- -------- Total income (loss) from operations $(3,176) $ 3,683 ======== ======== Interest Expense (in thousands): Corporate $ 42 $ 839 -------- -------- Total interest expense $ 42 $ 839 ======== ======== Benefit (Provision) For Income Taxes (in thousands): United States $ 79 $ (247) Latin America - (289) -------- -------- Total benefit (provision) for income taxes $ 79 $ (536) ======== ======== Capital Expenditures (in thousands): United States $ 185 $ 260 -------- -------- Total capital expenditures $ 185 $ 260 ======== ======== Number of Customers: United States 1 1 Latin America 1 3 -------- -------- 2 4 ======== ======== F-24 ENVIRONMENTAL SAFEGUARDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) __________ 13. SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION, CONTINUED ------------------------------------------------------------- 2002 ------ Assets (in thousands): United States $3,400 Latin America 228 Middle East 3,397 Corporate 54 ------ Total assets $7,079 ====== Long Lived Assets (in thousands): United States $3,320 Latin America 2 Middle East 3,390 ------ Total long lived assets $6,712 ====== During the years ended December 31, 2002 and 2001, the Company's largest customer accounted for 95% and 93% of revenue, respectively. 14. SUBSEQUENT EVENTS ------------------ In January 2003 we signed a contract to process various waste streams for Rineco Chemical Industries, Inc., an entity related to Rineco Recycling, LLC. In March 2003 we obtained a loan of $1,500,000 from Rineco Recycling, LLC. The loan is to be funded in three $500,000 fundings (less $40,000 in origination fees per funding) on March 20, 2003 (we have already received this funding tranch); May 15, 2003; and August 15, 2003. The loan is collateralized by three of our ITD units and bears interest at a stated rate of 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. We issued 1,500,000 warrants to purchase shares of our common stock at an exercise price of $0.01 per share in connection with this loan and these warrants were valued at $345,000. The loan origination fees and warrants results in an effective interest rate on the loan of approximately 35% per year. This transaction made Rineco Recycling, LLC a related party and the beneficial owner of 13% of our common stock, although none of the warrants have been exercised. Also during March 2003, the Company negotiated an extension of the maturity date of $250,000 of un-collateralized related party notes payable to September 16, 2003 (See Note 4). 15. NON-CASH INVESTING AND FINANCING ACTIVITIES ----------------------------------------------- The Company engaged in certain non-cash investing and financing activities as follows (in thousands): 2002 2001 ----- ----- Dividends declared but not yet paid. $ 253 $ 338 Stock warrants issued to extend the due date of senior secured notes payable. - 46 F-25 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. LIMITATION ON DIRECTORS' LIABILITY; INDEMNIFICATION Our Articles of Incorporation ("Articles") provide, as permitted by governing Nevada law, that our Directors shall not be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, with certain exceptions. These provisions may discourage stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders on behalf of us against a director. The Articles provide that we will indemnify our directors and officers against expenses and liabilities they incur to defend, settle, or satisfy any civil litigation or criminal action brought against them on account of their being or having been our directors or officers unless, in such action, they are adjudged to have acted with gross negligence or willful misconduct. Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Commission, such indemnification is against public policy as expressed in the Act and is therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by a small business issuer of expenses incurred or paid by a director, officer or controlling person of the small business issuer in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the small business issuer will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The inclusion of this provision in the Articles may have the effect of reducing the likelihood of derivative litigation against directors, and may discourage or deter stockholders or management from bringing a lawsuit against directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders. The Articles provide for the indemnification of our executive officers and directors, and the advancement to them of expenses in connection with any proceedings and claims, to the fullest extent permitted by the Nevada law. The Articles include related provisions meant to facilitate the indemnities' receipt of such benefits. These provisions cover, among other things: (i) specification of the method of determining entitlement to indemnification and the selection of independent counsel that will in some cases make such determination, (ii) specification of certain time periods by which certain payments or determinations must be made and actions must be taken, and (iii) the establishment of certain presumptions in favor of an indemnitee. 51 ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the estimated expenses to be incurred in connection with the distribution of the securities being registered. All of the expenses shall be paid by us, and shall not be borne by the Selling Stockholder. Reason Amount ---------------------------------------------- SEC Registration Fee $ 26.73 Printing and Engraving Expenses $ 300.00 * Legal Fees and Expenses $25,000.00 * Accounting Fees and Expenses $10,000.00 * Transfer Agent Fees $ 300.00 * ------------- Total $35,626.73 * ============= ----------------------- (*) Estimated. 52 ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES During the three year period ended April 21, 2003, we issued unregistered securities in transactions summarized below. The following transactions were effected on reliance upon exemptions from registration under the Securities Act of 1933 as amended (the "Act") as provided in Section 4(2) thereof or, upon exemptions from registration under the Act as provided in Regulation D thereof. Each certificate issued for unregistered securities contained a legend stating that the securities have not been registered under the Act and setting forth the restrictions on the transferability and the sale of the securities. No underwriter participated in, nor did we pay any commissions or fees to any underwriter in connection with any of these transactions. In March 2003, we issued 1,500,000 warrants to purchase our common stock to Rineco Recycling, LLC as part of the consideration for Rineco Recycling, LLC loaning us $1,500,000. We gave Rineco Recycling, LLC a promissory note for the loan proceeds. We valued this transaction at $345,000. These warrants have an exercise price of $.01 per share. We issued these securities in reliance on Section 4(2) of the Act. This transaction did not involve a public offering. The investor was knowledgeable about our operations and financial condition. We believe that the investor had knowledge and experience in financial and business matters that allowed it to evaluate the merits and risk of receipt of these securities. In 2000, we issued 400,000 shares of our Series D Convertible Preferred Stock in exchange for all outstanding shares of our Series C Non-Convertible Preferred Stock. This transaction was with our primary lenders. The newly issued shares of Series D Preferred stock are convertible into common stock at a present conversion price of $0.37 per share. We valued this transaction at $168,000. We issued these securities in reliance on Section 4(2) of the Act. These transactions did not involve a public offering. The investor was knowledgeable about our operations and financial condition. We believe that the investor had knowledge and experience in financial and business matters that allowed them to evaluate the merits and risk of receipt of these securities. In 2001, we issued an aggregate of 188,571 warrants to purchase common stock to the holders of our senior debt. We valued these transactions at $46,000. These warrants have an exercise price of $0.01 per share. We issued these securities in reliance on Section 4(2) of the Act. These transactions did not involve a public offering. The investor was knowledgeable about our operations and financial condition. We believe that the investor had knowledge and experience in financial and business In 2000, we issued an aggregate of 417,066 warrants to purchase common stock to the holders of our senior debt. We valued these transactions at $438,000. These warrants have an exercise price of $0.01 per share. We issued these securities in reliance on Section 4(2) of the Act. These transactions did not involve a public offering. The investor was knowledgeable about our operations and financial condition. We believe that the investor had knowledge and experience in financial and business matters that allowed them to evaluate the merits and risk of receipt of these securities. 53 ITEM 27. EXHIBITS The following exhibits are filed as part of this Registration Statement: Exhibit Number Description ________________________________________________________________________ Please note: The registrant has requested that portions of exhibits with the notation (J) be given confidential treatment and the registrant has filed a confidential treatment request with the Secretary of the Commission. In these exhibits, the registrant has omitted such material and the registrant has marked this exhibit with a mark " ***** "to indicate where material has been omitted.
3.1 (A) Certificate of Incorporation of the Registrant, as amended. 3.2 (A) Bylaws of the Registrant. 4.1 (A) See Exhibits 3.1 and 3.2. for provisions of the Articles of Incorporation and Bylaws of the Registrant defining rights of holders of common stock of the Registrant. 4.2 (A) Common Stock specimen. 4.3.1 (B) Certificate of Designation, Preferences, Rights and Limitations of Series B Convertible Preferred Stock. 4.3.2 (B) Certificate of Designation, Preferences, Rights and Limitations of Series C Preferred Stock. 4.3.3 (E) Certificate of Designation, Preferences, Rights and Limitations of Series D Convertible Preferred Stock. 4.4 (A) Form of Warrant Certificate dated December 17, 1997 (Included in Exhibit 4.8). 4.5 (A) Form of Registration Rights Agreement pursuant to Private Placement Memorandum dated September 18, 1996. 4.6 (A) Form of Registration Rights Agreement dated December 17, 997, between the Company and Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone. 4.7 (A) Form of Warrant Agreement dated December 17, 1997, between the Company and Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone. 54 4.8 (C) Form of Registration Rights Agreement dated December 7, 1998. 4.9 (H) Warrant Certificate of Rineco Recycling, LLC. 4.10 (H) Registration Rights Agreement of Rineco Recycling, LLC. 4.11 (H) Waiver of recalculation of conversion price by holders of Series B Preferred Stock. 5.1 (H) Opinion of Axelrod, Smith & Kirshbaum. 10.1.1 (E) Agreement in Principal dated August 17, 2000. 10.1.2 (F) Agreement dated March 1, 2001. 10.2 (A) Loan and Security Agreement dated December 17, 1997 by and among the Company, National Fuel & Energy, and OnSite Technology, L.L.C. as Borrowers and Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone, as Lenders. 10.3 (A) Form of Registration Rights Agreement pursuant to Private Placement Memorandum dated September 18, 1996. 10.4 (A) Form of Registration Rights Agreement dated December 17, 1997, between the Company and Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone. 10.5 (A) Form of Warrant Agreement dated December 17, 1997, between the Company and Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., Newpark Resources, Inc. and James H. Stone. 10.6 (A) Employment Agreement of James S. Percell. 10.7 (D) 1998 Stock Option Plan 10.8 (H) Promissory Note payable to Rineco Recycling, LLC. 10.9 (H) Security Agreement for Promissory Note payable to Rineco Recycling, LLC. 55 10.10 (H) (J) Contract to process various waste streams for Rineco Chemical Industries, Inc. 10.11 (H) (J) Amendment to contract to process various waste streams for Rineco Chemical Industries, Inc. 10.12 (H) Loan commitment letter 16.1 (G) Letter from PricewaterhouseCoopers LLP 21.1. (H) Subsidiaries 23.1 (H) Consent of Axelrod, Smith & Kirshbaum (included in Exhibit 5.1). 23.2 (H) Consent of Ham, Langston & Brezina L.L.P. 23.3 (H) Consent of PricewaterhouseCoopers LLP
--------------- (A) Previously filed as an exhibit to the Company's Annual Report on Form 10-KSB as amended for the fiscal year ended December 31, 1997, and incorporated by reference thereto. (B) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated December 17, 1997 and filed December 30, 1997, and incorporated herein by reference thereto. (C) Previously filed with Form S-3 as amended effective Feb 8, 1999, and incorporated herein by reference thereto. (D) Previously filed as an exhibit to the Company's Annual Report on Form 10-KSB as amended for the fiscal year ended December 31, 1998, and incorporated by reference thereto. (E) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated August 17, 2000, and filed August 28, 2000, and incorporated herein by reference thereto. (F) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated March 1, 2001, and filed March 6, 2001, and incorporated herein by reference thereto. (G) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated April 2, 2002 and filed April 9, 2002 and incorporated herein by reference thereto. 56 (H) Submitted herewith. (J) The registrant has requested that portions of exhibits with the notation (J) be given confidential treatment and the registrant has filed a confidential treatment request with the Secretary of the Commission. In these exhibits, the registrant has omitted such material and the registrant has marked this exhibit with a mark " ***** "to indicate where material has been omitted. 57 ITEM 28. UNDERTAKINGS (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offer or sales are being made, a post-effective amendment to this registration statement: i. To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; ii. To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; and iii. To include any additional or changed material information with respect to the plan of distribution. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) i. That, for the purpose of determining liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4), or 497(h) under the Securities Act of 1933 shall be deemed to be part of this registration statement as of the time it was declared effective. ii. That, for the purpose of determining liability under the Securities Act of 1933, each post- effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (b) Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. 58 In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. 59 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and authorized this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, County of Harris, State of Texas, on April 29, 2003. ENVIRONMENTAL SAFEGUARDS, INC. (signed) ----------------------------- By: /s/ JAMES S. PERCELL JAMES S. PERCELL Director, Chairman of the Board, Chief Executive Officer and President In accordance with the requirements of the Securities Act of 1933, this registration statement was been signed by the following persons in the capacities and on the dates indicated:
Signature Title Date --------------------------------- ------------------------------------- -------------- (signed) --------------------- /s/ JAMES S. PERCELL Director, Chairman of the Board, April 29, 2003 JAMES S. PERCELL Chief Executive Officer and President (signed) --------------------- Director THOMAS R. BRAY (signed) --------------------- /s/ BRYAN SHARP Director April 29, 2003 BRYAN SHARP 60 (signed) --------------------- /s/ ALBERT WOLFORD Director April 29, 2003 ALBERT WOLFORD (signed) --------------------- /s/ DAVID L. WARNOCK Director April 29, 2003 DAVID L. WARNOCK (signed) --------------------- /s/ MICHAEL D. THOMPSON Chief Financial Officer April 29, 2003 MICHAEL D. THOMPSON and Secretary
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